Watch Out For The Bear Trap As Markets Become Oversold

Sellers continued to pound the September Crude Oil futures contract this week as support failed at two key retracement levels. The current downside momentum suggests the market could be headed lower, however, we expect the selling to subside a little as the market approaches a former bottom and change in trend point.

Due to the steepness of the current break, we have to be aware of oversold conditions. Some traders use oscillators and indicators to identify this condition, however, I prefer to use the closing price reversal bottom.

This chart pattern can form on an intraday chart, a daily chart or a weekly chart. It is basically defined as a lower-low than the previous time period, a higher close, a close above the opening price for that time period and a close above the mid-point of that time period's range. There is no math. It's all price action and order flow.

The chart pattern doesn't indicate a change in trend is taking place, but actually a shift in momentum. It is often accompanied by a huge volume spike because when it occurs, buyers will be willing to pay anything to get out of their short positions.

The closing price reversal chart pattern also means the buying is greater than the selling at current price levels. After it forms and is confirmed with a follow-through move, it could lead to a 2 to 3 week correction into a short-term retracement area or resistance zone.

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Technically, the main trend is still up, however, momentum has been to the downside since the $52.73 top the week-ending June 10. That's 7 weeks so crude oil is officially in the window of time for a closing price reversal bottom.

The main range is $32.85 to $52.73. Its retracement zone is $42.79 to $40.44. This zone is currently being tested and was our primary downside target. Sellers took out the 50% level at $42.79 pretty fast this week, but they may have a harder time at the lower or Fibonacci level at $40.44 since it is slightly above the main bottom at $38.67.

Next week, we're going to be watching the price action very closely as the market approaches a serious support area. The first support is the Fib level at $40.44. This is followed by the uptrending Gann angle (Green) at $39.85 and the main bottom at $38.67. We suspect that somewhere between $40.44 and $38.67, buyers will start to come in. Some will be buying to protect profits. Others will be buying because of value. Still others will be coming in to defend the trend.

A trade through $38.67 will turn the main trend to down according to the weekly swing chart. Since we will be eight weeks from the top, however, I don't expect an acceleration to the downside through this level. In other words, be careful shorting weakness through this level. The odds are we are closer to a bottom than the start of another leg down so you don't want to get caught on the wrong side of the market at an eight week low if there is a reversal to the upside. Selling weakness or through a swing bottom usually works best 2 to 4 weeks off a top.

On the upside, the first resistance is the main 50% level at $42.79 and the short-term Fibonacci level at $44.04. This is followed by the steep downtrending angle (Blue) at $44.73.

We're going to stick with our original forecast of a test of $40.44 the week-ending September 2 (Circled Area). However, based on the current downside momentum, we have to concede that September Crude Oil could rally into this area if the aggressive selling pressure continues to take out important support levels.

The key next week is to avoid "the giveback". If short then most of the open profits will be yours if you implement your exit strategy correctly. Identifying a closing price reversal bottom on either the intraday, daily or weekly chart as soon as possible may offer you the best opportunity to book most of your open profit.

Otherwise, you have to think about moving buy stops to slightly above former support levels at $42.79, $44.04 and the downtrending angle at $44.73. It all depends on how much of your profit you are willing to give back.

In conclusion, September Crude Oil is currently accelerating to the downside. However, we are in the window of time for a closing price reversal bottom. Short-sellers should be a little defensive at the start of the new week and have exit strategies in place rather than trying to figure out where to add to your short positions.

It's always better to get out of your positions on your terms than to let the market take you out on its terms because it tends to make you pay dearly. Stay short crude oil, but have an exit strategy in place because of the strong possibility of a reversal bottom next week.