Prepare For Volatile Oil Markets As Technical And Fundamental Traders Clash

Crude Oil Outlook

April Crude Oil showed strong resilience over the last two weeks, but both moves were related to technical factors. The fundamentals remain bearish, but that didn't stop the buyers from bargain hunting after the release of the latest weekly U.S. Energy Information Administration inventory report. The clash between the technical and fundamental traders is likely to lead to volatile trading conditions so prepare for the possibility of a choppy, two-sided trade over the near-term. 

The daily chart pattern demonstrates that traders are focusing on two chart patterns. The short-term pattern shows that a range has formed between $44.37 and $55.05. Its 50% to 61.8% retracement zone at $49.71 to $48.45 is controlling the short-term direction of the market. On February 5, traders tested this zone, briefly breaching it to $48.20. The second test was on February 11 when the market reached a low inside the zone at $48.93. Based on the price action and order flow inside this zone, it's safe to say that buyers are trying to establish support inside this zone.

The basic definition of an uptrend is "a series of higher tops and higher bottoms. A change in trend occurs when a previous top is overtaken. On February 3, April Crude Oil turned the trend to up on the daily chart when the previous high at $52.27 was taken out.

Following a top at $55.05, the market proceeded to break to $48.20 where it established a new higher bottom. Unfortunately for the bullish traders, the subsequent rally stopped at $54.71. Now that the higher bottom has been established, buyers are going to try to reaffirm the uptrend with a breakout over the last top at $55.05.

If this occurs then a potentially bullish secondary higher bottom will be confirmed at $48.20 and trend traders will either buy strength or exit previous short positions. If sellers continue to remain firm then the attempted rally will fail and the downtrend will resume. The tone of the market over the near-term will be determined by trader reaction to $49.71 to $48.45.

The main range is $77.75 to $44.37. The retracement zone created by this range is the primary upside target at $61.06 to $65.00. Another way to protect a target is to take a look at the first rally. The move from $44.37 to $55.05 was $10.68. Adding this figure to the recent bottom at $48.20 makes $58.88 another potential target.

While the news has been covering U.S. production, the real development has been in the price action. The production news is a stale event. The price action is closer to real time. In real time, it looks like the hedge and commodity funds have been lightening up on their short positions. They are likely to speed up the short-covering process if enough buyers come in to defend the market at $49.71 to $48.45. Fundamentally, something has to happen that will encourage more short-covering over $55.05 as well as fresh buying.

Fundamentally, the bearish news this week was that U.S. producers pumped out an average of 9.2 million barrels of crude oil daily during the week-ended February 6. According to the federal government, this was a record.

The latest data from the U.S. Energy Information Administration also showed that daily U.S. production rose an average of 49,000 barrels. In addition, U.S. crude stockpiles also increased by nearly five million barrels to 417.9 million barrels.

Although the government report initially drove prices lower on February 11, the market rebounded the next day. Traders reacted as if the production numbers were old news. The reaction was likely triggered by speculation of future events. In this case, buyers may have reacted to the peace agreement between Russia and Ukraine and the possibility that this will stop future sanctions against Russia or even optimistically lead to the lifting of current sanctions.

Additionally, Ukraine was offered $40 billion by the International Monetary Fund to help it recover from the economic crisis triggered by the Russian invasion and the subsequent fighting. This money will likely be used to shore up the economy which should translate into future demand for crude oil.

So while U.S. production may be at record highs, there is hope for the bulls from the demand side of the equation. Combining the potentially bullish fundamentals and the technical chart picture creates a low risk environment for those considering the long side. At the very least, speculators have identifiable exits if wrong on the move which is a lot better than buying during a freefall. For those already long the market, let's hope the hedge and commodity funds recognize a possible change in the fundamentals and shift sentiment to bullish.