Crude At A Crossroads: Is A Reversal Top In The Making?

Since late September, the U.S. Dollar and crude oil have been rallying simultaneously with traders seemingly ignoring the typical relationship between the two assets. Since crude oil is a dollar-denominated asset, it tends to move in the opposite direction of the U.S. Dollar. In theory, a stronger dollar lowers demand for crude oil because it makes the asset more expensive to foreign buyers.

At times, however, we see pockets of activity on the charts when this relationship does not follow the "rules". We may have just witnessed one of those times with speculators driving crude oil sharply higher on the news that OPEC has a deal in place to curtail output. At the same time, the U.S. Dollar rose sharply because of a rising in U.S. Treasury yields. Investors drove up yields as the chances for a rate hike in December increased greatly.

On October 20, crude oil fell more than 2 percent, erasing the previous day's gains on profit-taking after the U.S. Dollar spiked higher after several days of sideways-to-lower activity due to worries over the timing of the next Fed rate hike.

In my opinion, crude oil traders started out a little tentative about playing the long side of the market because of the price action the day before.

Crude oil surged on Wednesday, October 19 after the U.S. Energy Information Administration reported its sixth drawdown in seven weeks. The move was primarily driven by the news of a drop of 5.2 million barrels, while refineries only ran at 85 percent. Traders also cited lower-than-expected crude imports as another possible reason for the draw.

Thursday's weakness shouldn't have come as a total surprise to chart-watchers, because the bullish news on Wednesday failed to trigger a decisive rally through last week's high at $52.16. All the good news derived from the EIA report was only strong enough to take the market to $52.22, just six-cents higher than the previous week.

The market also closed below the previous high, indicating that the selling was greater than the buying at current levels. This also suggested that perhaps speculators were done buying strength on hopes and wishes regarding OPECs deal to curb output, and were now waiting for real evidence that the deal would be approved. This may not be known, however, until November 30 when the cartel meets in Vienna for its official meeting.

Other reasons for the developing weakness were the stronger U.S. Dollar, which could limit demand. And bearish speculation that perhaps refinery activity had reached a seasonal low and was getting ready to increase. This would take care of the surprise string of inventory drawdowns.

The ground work appears to have been laid for the start of a near-term correction, but we're going to have to see evidence on the weekly chart before we consider lightening up on the long side or playing the short side. We could get this signal on Friday, October 21.

Weekly December Crude Oil Technical Analysis

(Click to enlarge)

According to the Weekly December Crude Oil chart, the main trend is up. However, the upside momentum may be showing signs of weakening as the market struggles between the June main top at $53.62 and the August main top at $50.59.

At this time, the buying doesn't seem to be strong enough to take out $53.62, or weak enough to ball back below the previous top at $50.59. If these conditions prevail then we could be looking at a sideways trade over the near-term.

This chart pattern essentially means that buyers are waiting for strong enough bullish news to create the upside momentum needed to drive this market through $53.62.

Bullish traders are looking for any excuse to book profits after the tremendous rally from $43.77 the week-ending September 23. Bearish traders are looking for signs of a collapse of the proposed OPEC deal and for renewed increases in U.S. inventory.

From a technical prospective, one sign of increasing selling pressure will be a break under the previous top at $50.59.

Another sign of a potential top will be a closing price reversal top chart pattern this week. We already saw a higher-high than the previous week on a rally to $52.22. Now all we need is a close below last week's close at $50.75 to offer further proof that the selling may be greater-than-the buying and that momentum is shifting to the downside.

If December Crude Oil closes below $50.75 on October 21 then look for confirmation next week. If confirmed, we could be witnessing the start of a 2 to 3 week correction that could drive the market into the 50% to 61.8% retracement zone formed by the $43.77 to $52.22 trading range. This zone is $48.00 to $47.00.

Watch the price action and read the order flow at $50.75 on October 21. Trader reaction to this level will tell us if the buyers are coming in to defend the uptrend, or if sellers are taking control. Furthermore, continuing strength in the U.S. Dollar could also help pressure crude oil prices.