Back to top

Image: Bigstock

Is Natural Gas a Mean Reversion Play?

Read MoreHide Full Article

An old Wall Street saying warns investors not to “Catch a falling knife.” The saying has merit in that often, the most straightforward trade an investor can make is to latch onto an already existing trend because “The trend is your friend.”

However, some investors can make countertrend trading work. Countertrend trades offer some distinct advantages, including:

More considerable “reversion to the mean” potential: By definition, an investor who successfully times a buy in a beaten-down stock has more profit potential. When a stock or investment vehicle is stretched far in one direction, it often snaps back like a rubber band, and the reversion to the mean trade can be breathtaking.

Sentiment: When an investor buys a heavily beaten down asset, they go against the grain and trade in a contrarian state of mind. If timed correctly, the rewards for this type of trade can be fruitful.

Investor Preference: Like all things in life, there are “Different strokes for different folks.” Some investors may prefer to or jive better by buying heavily discounted investment vehicles.

Is Natural Gas Setting Up for a Reversion to the Mean?

Looking at today’s market, one of the most brutal downtrends is in Natural Gas. Over the past year, the United States Natural Gas Fund ETF ((UNG - Free Report) ) has been down 77%. Meanwhile, the ProShares Ultrashort Bloomberg Natural Gas ETF ((KOLD - Free Report) ) is up 236% over the same time.

Despite the poor performance of natural gas, some technical signs are beginning to appear that suggest that the downtrend may be getting long in the tooth, including:

Close Above MA: The 50-day moving average is a guide used by intermediate-term investors to size up the trend. After being rejected at the underside of the moving average for months, last week, UNG closed above the 50-day moving average for the first time since December 2022.

Zacks Investment Research
Image Source: Zacks Investment Research

Bullish Divergence: The Relative Strength Index is a technical indicator used to measure momentum. A bullish divergence occurs when underlying asset’s price makes new lows while the RSI makes higher lows. Currently, UNG is showing a massive divergence between the RSI and price – suggesting that bearish momentum is slowing dramatically.

Zacks Investment Research
Image Source: Zacks Investment Research

Blowout Volume: When a heavily beaten-down asset carves out lows, it almost always comes with a blowout or “capitulation” in volume. In the past few months, UNG has recorded its highest volume levels in history – a sign that beaten-down bulls may be finally throwing in the towel and making way for a new uptrend.

Zacks Investment Research
Image Source: Zacks Investment Research


Buying beaten-down assets has its share of positives, including reversion to the mean potential and sentiment. The price and volume action in the natural gas ETF is an example of an asset that may be set up for a significant reversion to the mean move. If natural gas is to recover in the coming months, natural gas-related stocks such as Chesapeake Energy ((CHK - Free Report) ) and Vital Energy ((VTLE - Free Report) ) stand to benefit.

Published in