A Good Sign For Bullish Traders… With A Catch

October Crude Oil

Technical Analysis

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October Crude Oil futures are in a position to finish the week higher after an impressive follow-through rally, following last week's potentially bullish closing price reversal bottom chart pattern. Although the main trend is still down according to the weekly chart, the chart pattern indicates a shift in momentum to the upside.

If the rally continues then look for crude oil to test the first two objectives at $50.20 and $51.25. Since the trend is down, sellers are likely to come in following a test of this zone. If the buying is strong enough to continue the move, then the rally may extend into $53.14 to $54.43.

The first rally after a prolonged move down is usually short-covering. Buyers don't usually come in until a support base is established. The initial rally was $37.75 to $49.33. Early last week, the market tested its retracement zone at $43.54 to $42.17. There was a strong technical bounce on a test of this zone, suggesting that aggressive buyers may have enough to support the market.

This is a good sign for bullish traders, however, the market may test the short-term retracement zone several times before a solid support base forms. In the meantime, crude oil may bounce between $43.54 and $50.20 while the bulls and the bears battle it out for control.

A failure to hold $42.17 will signal that sellers have regained control. In this case, buyers are not likely to come in until the market gets closer to $37.75.

The problem for the bullish traders is that they are racing against the clock. This chart pattern typically leads to a 2 to 3 week rally equal to at least 50% of the last break before the selling pressure resumes. We have already determined that the 50% targets are $50.20 to $51.25. Therefore, the buying is going to have to be strong enough to either take out the 50% targets or hold the bottom for more than 3 weeks to indicate it is being controlled by strong buyers.

The price action has already suggested that the buying at this time is stronger than the last time it rallied from the week-ending May 29 to the week-ending June 12. That rally was from $57.32 to $62.65, or $5.33. The current rally is $11.58 so this move has exceeded the previous rally in terms of price. The best rallies occur when time overbalances the previous rally. In this case, a stronger rally will be indicated if the market can continue to make higher-highs on the weekly chart beyond the week-ending September 12.

To put it simply, when looking at price only, the buying is going to have to be strong enough to sustain a rally over $51.25 in order to maintain the current upside momentum. If looking at time, this rally has to be sustained beyond September 12, or the selling pressure is likely to resume and we will have to conclude that we've just experienced a rally in a bear market.

Fundamental Analysis

The supply and demand fundamentals support a sideways to lower trade at this time. This is because of the supply glut. Speculation is supporting the rally. Fear is also fueling the short-covering.

Because of the supply glut, there is still a strong bias to the downside. The majority of the shorts still in the market are in there because demand is not strong enough to overtake the combined overproduction by the U.S. and OPEC. These traders will be waiting for a test of $51.25 to $50.20 in order to refresh their strong short positions.

Unless there is a dramatic shift in supply and a downtrend begins to develop, the market is likely to be controlled by the major short-sellers. Therefore, the main trend will remain down.

Speculators are also known as "hit and run" traders. When momentum shifted to the upside, these traders jumped in to take advantage of the price action. They will continue to play the long side as long as the momentum is pointing up and will leave once it stops. They are not interested in trading the trend. They want the action.

If crude oil rallies to $50.20 to $51.25 over the near-term then look for the speculators to begin taking profits when the major short-sellers decide to come in to refresh their positions.

Those investors, driven by fear, are going to continue to cover if the news continues to support the possibility of a bottom. The key story driving the market at this time is that OPEC agreed to address some of the overproduction concerns with its members. The next major OPEC meeting is December 4. Just considering adjusting its production levels sooner than expected has put enough fear into the short-sellers to encourage them to adjust their position size just in case OPEC decides to cave in to the pressure of its constituents.

Summary

In summary, since we are in a news-driven market, fresh news is going to continue to drive the volatility and the price action. If news breaks supporting an early production cut by OPEC then the market will rally on short-covering. Given the size of the supply, I don't think the major players are going to chase this market higher.

If the news is bullish then shorts will continue to cover, however, the real buying will come in on a correction back towards the main bottom at $37.75.

The longer OPEC waits to make a decision about adjusting its production levels, the weaker the market may become from current price levels because speculators are not going to want to hang around waiting for fresh bullish news. Speculator liquidation would be bearish for prices.

Given the two-sided nature of the news, I expect the market to bounce between $50.20 and $43.54 over the near-term until fresh news regarding OPEC hits the market.