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After an unseasonably chilly winter in the Midwest and on the East Coast, the cold weather has continued into the first week of spring.
This has caused a big spike in the price of natural gas, as the clean-burning fossil fuel is the primary fuel used to heat homes and businesses.
Year to date, the value of United States Natural Gas (NYSE: UNG), an exchange-traded fund (ETF) pegged to the spot price of natural gas, is up almost 20%.
That big surge is also reflected in the price of the primary futures contract for natural gas, known as the Henry Hub. According to the U.S. Energy Information Administration (EIA), the Henry Hub front-month contract now trades just under $4.
This is a far cry from this time last year, when natural gas traders were concerned the Henry Hub front-month contract would sink below $1. The near four-fold rise in natural gas futures during the past year has been impressive, and if the current metrics in the space hold up, we could see natural gas prices continue to burn hot.
Interestingly, in Monday trade, natural gas prices fell about 1.5% after initially rallying to $4. The reversal that day came on reports of warmer weather in the coming weeks.
Now, keeping in mind the big run higher we've seen in UNG since mid-February, this trade does feel a bit overbought. However, I suspect more cold weather will erase that technical headwind.
Perhaps more important, the overall metrics in the space are bullish for UNG. The colder-than-normal winter has caused a big reduction in the natural gas inventory surplus. That's caused the EIA to conclude that natural gas storage levels at the end of the heating season will be well below what they were at this time last year.
Moreover, demand remains strong; if you live in the Midwest or on the East Coast, you don't need me to tell you that people have been turning up the dial on their heaters.
Now, if you're going to trade this sector, you have to be very nimble. Natural gas is notoriously volatile, and as such, I think we're looking at a four-week trade at best. If more cold weather continues to pressure natural gas supplies, it could cause UNG to spike another 10% by mid-April.
If you do jump on the natural gas ETF trade here, then make sure you set a tight stop-loss -- no more than 7% below your entry price -- and then use a trailing stop to protect profits.
Recommended Trade Setup:
-- Buy UNG at the market price-- Set initial stop-loss at $20.21, approximately 7% below the current price-- Set initial price target at $23.90 for a potential 10% gain in four weeks
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