Consider This ETF as a Hedge

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

By Scott Pluschau for ETF Digest

NEW YORK ( ETF Digest) -- UGA, the United States Gasoline Fund ( UGA) is a way for investors and hedgers to manage their exposure to gasoline prices. This exchange traded fund is designed to reflect changes in percentage terms of the price of gasoline as measured by the change in the price of the gasoline futures contract traded on the New York Mercantile Exchange.

Let's take a look at the chart below. UGA formed a breakaway gap from a "Descending Triangle" pattern to start 2012. A descending triangle pattern shows demand at a fixed price level which is where I drew the blue horizontal trendline. It also shows increasing supply pressures with each rally off of support marked by the falling blue trendline.

Eventually either the demand or the supply is going to be depleted by the other. Normally this is a very bearish pattern, since once demand has been depleted; you can almost hear on the chart "look out below." The path of least resistance is lower below $45. Why? Traders who were buying and holding inside the triangle now have a losing position and potentially will be looking to cut losses. This increases supply. Bids become smart money doesn't like to catch a falling knife. Increasing supply with decreasing demand means down we go in price. Eventually the market hits a stopping price where the prior sellers are gone and long term investors now believe there is value and step in for a bargain. This is the reality of a two way auction.

The breakout that we see now on the other hand is not the most bullish indicator. What happened does signal a potential change in trend when the trendline is broken to the upside but you may still have some buy and hold investors at higher levels looking to get out. This can cause a false breakout. Volume was not that strong so this has potential to fill the gap.

I do not rely on technical indicators to make trading decisions, but it's worth pointing out that we had a MACD centerline crossover while UGA was inside the triangle as well as some prior positive bullish divergence the last time UGA was bouncing on support. This was a signal to some technicians that momentum was building to the upside.

I would like to see Gasoline fill the gap and retest that backside of the falling trendline to see if any additional supply comes in. Any move back above this recent high afterward will be bullish and have me taking trades.

A longer term investor might find the horizontal support a great place to put a protective stop, but keep in mind this would be about a 10% move if you are proven wrong. Position sizing would be critical to keep losses to a minimum. Position sizing has everything to do with your account size and how much you are comfortable risking in capital (or how much you drive, since you may offset losses in your UGA hedge at the pump).

UGA often trades less than 100,000 shares so this is not a wise day trading vehicle.

Subscribers to ETF Digest get email alerts for trades being place in the model portfolios.

Follow this writer on Twitter/ScottPluschau

Comments are welcome at Scott.Pluschau@ETFDigest.com

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.