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Oil Prices: Fundamental And Technical Analysis Conflict

Analysis of markets of any kind, stocks, bonds, currencies or commodities basically falls into one of two categories, fundamental and technical. In an ideal world both types of analysis support trading in a particular direction. When that is the case the short term moves that technical analysis usually indicates can be used to set up a longer-term position that allows you to take advantage of the fundamental picture. Sometimes, however, it is not that simple as each way of looking at things indicates a move in a different direction. That is where we are at right now in WTI, and that raises the question of which to believe. The answer is both.

In the oil market, fundamental analysis deals with what I usually refer to as “big picture” matters. These are the things that have a bearing on the most basic drivers of price: supply and demand. They include macro issues such as the prospects for world economic growth, and the domestic regulatory environment as well as more specific factors such as output levels and stockpiles both here and overseas. From that perspective, the dispute between Saudi Arabia and Qatar calling the OPEC agreement to restrict production into question, an oil friendly White House and Congress, a recent wobble in growth and a series of terrible inventory reports all point to further drops in WTI.

Technical analysis, on the other hand, is concerned with reading charts and predicting moves based on previous pricing patterns. As you would imagine, technical analysis is usually considered to be more reliable in predicting short-term moves, while fundamentals tend to drive things over time. That is not always the case, though. Sometimes, by looking at a chart that covers a year or more with intervals of a day or more you can see long term price trends. That makes sense when you consider the fundamentals of supply and demand theory. That states that higher prices encourage increased production, which lowers prices to the point where production is increased, leading in turn to higher prices. That can, however, happen in the context of a trend driven by fundamentals. When that occurs, the chart looks exactly like the one day candle chart for WTI over the last four months.

(Click to enlarge)

The downward-sloping nature of the channel indicated on the chart is the result of all the fundamental factors noted above, but the fact that we are right at the bottom of that channel suggests that we are at one of those pivot points for prices, and we will go higher from here.

Those two analyses seem to conflict, but in the context of the chart pattern above there is no reason why both cannot be true. It is quite possible to bounce off this level but remain well within the downward sloping channel that reflects the fundamental realities in the global oil market. That is what I expect to happen from here. At some point the big picture issues will presumably be resolved and the way will be clear to reverse the long term trend, but for now trading on the assumption that both the technical and fundamental analysis is correct, and therefore in expectation of an “up-down-up” pattern in the near future, looks to be the best strategy for traders.




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