Oil Markets Approach Battle Zone

June West Texas Intermediate crude oil futures closed more than 1 percent higher on Thursday, putting the market in a position to post a solid gain for a second consecutive week. Despite the strength into the latter half of the week, traders remained skeptical about the market's ability to sustain its current upside momentum.

The U.S. Energy Information Administration's (EIA) weekly report released on Wednesday showed crude inventories at record levels for the week-ending March 31. Initially, traders responded by selling. However, the move was short-lived and by Thursday, aggressive counter-trend buyers were back, putting the market in a position to challenge the week's high.

While some analysts are claiming that the current run-up is being supported by improving refinery runs in anticipation of the spring/summer driving season and a decline in gasoline inventories, I think that some of the credit for the move can be placed on speculative buying ahead of a possible announcement of an extension of the OPEC-led plan to cut output, trim the global supply glut and stabilize prices.

However, as a technical trader and a price action guy, I think the best thing that happened to this market over the past month has been the aggressive trimming of positions by hedge funds and commodity money managers. When they built record long positions earlier in the year, they essentially jammed up the market and it had nowhere to go.

Now that the number of long positions have eased, traders have what they like best, an open playing field where they can play both the long and the short side of the market. These traders like volatility and a two-sided trade. The professional money managers like to "set it and forget it" and hope for a trend to develop.

Unfortunately, I don't believe the market is ready to trend yet. We may see periods of upside momentum like we are experiencing now, but these are likely to be offset by periods of downside momentum.

The other thing you should note from the activity the past month is that rallies in this type of trading environment are a grind and breaks are fast and furious. This is because investors are being careful about playing the long side on the way up. At the same time, they all head for the exit at the same time when there is bearish news. I suspect that this type of "action/reaction" trading is likely to continue for several more months.

Technical Analysis

Weekly June West Texas intermediate Crude Oil

(Click to enlarge)

The main trend is up according to the weekly swing chart. The recent downswing from $57.95 to $47.58 was fueled by momentum, but the trend never turned down because the swing bottom at $46.25 was not violated.

The two-week rally from $47.58 has formed a new main bottom. It is actually another higher bottom in the series of higher bottoms going back to late January 2015. This is very encouraging for longer-term bullish traders.

Even if $47.58 failed as support and the trend changed to down, value-seeking investors would probably come in to buy crude oil inside the major retracement zone at $47.07 to $44.50. So I think this market is well protected on the downside. Now if OPEC decides to pull the rug out from under the market by ending its program then we could have problems if $44.50 fails as support.

The new short-term range is $57.95 to $47.58. Given the current upside momentum, the market is within striking distance of its retracement zone and primary upside target at $52.77 to $53.99.

The retracement zone at $52.77 to $53.99 is very important. It will be the battleground that decides whether buyers take June WTI to $57.95 the end of April, or if sellers regain control and drive prices back towards $47.07 to $44.50 over the near-term.

Next week, traders should watch the price action and read the order flow at $52.77 to $53.99. Trader reaction to this zone will tell us if the buying is strengthening, or if the sellers are regaining control.