With U.S. production levels remaining steady and OPEC not showing any signs of letting up on its current daily production output, investors may have to turn to technical analysis to get an early indication of bottoming action by crude oil futures.
There are numerous technical indicators or oscillators to watch, but most are coincidental. In other words, they tend to turn higher after the market has reached its bottom and rallied. Furthermore, when looking at the raw data generated by these types of indicators, they often indicate that conditions have been oversold for several weeks, further supporting the notion that they lag rather than lead the market.
Experience has shown that following the price data rather than the smoothed oscillator data shows what traders are actually doing. The swing chart is one tool used to determine if the selling pressure is picking up momentum or slowing down. The data pulled from this chart shows whether the selling pressure is expanding or contracting. This is essentially an indicator that shows whether the sellers have enough confidence to continue to press the market lower aggressively, or whether they are lightening up on their conviction.
When a market is trending lower like crude oil, bearish traders tend to press it lower more aggressively near a top when it first starts to show signs of weakness. The selling begins to expand when speculators pick up on the technical trend and the bearish fundamental news. As the market begins to approach a key support level, short-covering begins as well as aggressive counter-trend buying.
One of the best indications to observe is a break in the dominant pattern. It is generally accepted that as a bear market develops, the sell-offs in price are greater than the rallies. As a market nears a bottom, the selling pressure begins to diminish and the rallies begin to become larger. This is what is happening in the market at this time. Based on the price action this week, it looks as if March Crude Oil has reached a bottom and may be getting ready to turn higher.
Since the long-term fundamentals are bearish, any rally is likely to be technically related. Even if you aren’t technically oriented, you have to accept that it is possible that the technical price action may be ahead of the fundamentals so any change in trend based on the chart pattern has to be taken seriously since even the subtlest chart pattern can develop into a strong rally.
To simplify matters, let’s look at the three rallies prior to this week’s price action. The first from November 4 to November 10 was $3.51. The second from December 16 to December 22 was $4.55. Finally, the rally from January 7 to January 9 was $2.72.
This week, the market rallied from $44.78 to $51.73, or $6.95. Since this rally was greater than the previous rally, one can conclude that the buying may be greater than the selling at current price levels.
Another subtle change was the fact that the market crossed a previous top for the first time since early August. After reaching $44.78 on January 13, the subsequent rally to $51.73 took out the previous top at $50.07. This is even a stronger sign that the trend has turned up on the daily chart or that crude oil is getting closer to the bottom.
The first rally is usually caused by short-covering. The next rally will be caused by a combination of short-covering and aggressive buying. If the next CFTC Commitment of Traders report shows that money managers and hedge funds are lightening up on the short side then traders should prepare for the start of a substantial short-covering rally.
Although the basic supply and demand fundamentals suggest that a weakening global economy and overproduction are likely to keep the downside pressure on crude oil, there was a development this week that could help alter the short-term supply/demand picture.
According to Bloomberg, there is evidence that investors are moving oil into storage tanks in order to sell it later at a higher price. The fact that nearby futures prices are lower than prices in the future has created a scenario whereby investors can buy cash oil at lower prices today and sell it into the future at profitable price levels. This scenario is called contango and is a rare occurrence.
The reversal to the upside in the futures market this week may be reflecting traders trying to take advantage of this price anomaly. The increased buying of the March contract could help trigger a strong short-covering rally. The chart pattern suggests that the market is beginning to bottom.
The key price level to watch on Friday, January 16 is $48.99. A close over this price at the end of the week will be a strong indication that buyers are coming in or that sellers are lightening up. The daily chart is already showing signs of bottoming. A price anomaly is creating a potentially bullish scenario. All it may take is a higher close on the weekly chart to trigger the start of perhaps a 2 to 3 week rally.