We’re Close To Forming A Major Bottom For Oil

All eyes will be on Friday's close this week in the May Crude Oil futures market because of the breaking news on Thursday regarding the anticipated OPEC production freeze meeting on March 20 in Moscow. Speculative buyers drove the market higher during the week in anticipation of such meeting, and these same traders could take the market down if the meeting becomes a non-event.

Supply rose again last week according to the U.S. Energy Information Administration, but traders decided to ignore this news, instead shifting their focus on the possible meeting. The theme this week for traders appeared to be "focus on the future and not on the past". The future is a possible production freeze and lower U.S. production. The past is oversupply caused by excessive production from OPEC and the U.S. producers.

Crude oil prices had settled into a sideways-to-lower range earlier in the week on demand concerns from China, but news of a potential meeting to discuss a production freeze between OPEC and Non-OPEC countries triggered a massive recovery.

The meeting, led by Saudi Arabia and Russia, was expected to be a discussion about a global pact on freezing production, however, doubts about the meeting were cast late in the week because Iran had yet to say whether it would participate in such a deal. In February, Iran said it would ramp up production to try to get back to pre-sanction levels as quickly as possible and that the production freeze plan was a "joke".

Traders are expected to lean on the market which could put a cap on the rally if the idea that the meeting may not happen at all continues to gain traction.

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Technically, the main trend is still down on the weekly chart. However, momentum has been to the upside since the May futures contract reached lows on January 20 at $29.85 and $30.67 on February 11.

The main range on the weekly chart is $51.63 to $29.85. Its retracement zone and primary upside objective is $40.74 to $43.31. Since the main trend is down, we expect sellers to show up in this zone to re-establish their short positions.

This week's rally to $40.32 came close to testing the lower or 50% level at $40.74. However, sellers may have come in a little earlier because of the news. Nonetheless, the price action indicates that the market is not trading out of control and that it is very similar to any other bottoming action.

Earlier in the week, Goldman Sachs analysts said the rally is not sustainable given the fundamentals. This may be true per se because long-term bull markets tend to develop after solid support bases have been built and the fundamentals change from bearish to bullish.

Looking at the weekly May Crude Oil chart, it is pretty obvious that this current rally developed after one main bottom was created at $29.85. Sure there was consolidation for several weeks before the market moved higher, but in my opinion, the market still needs to spend some time establishing a good support base before we can say the bottom is in.

There is an old adage in the markets that says, "The height of the market is determined by the length of the base". I don't see a base at this time so crude oil may have to spend some more time between $40.00 and $28.00, trying to build the best base possible to support a bull market.

The first rally up from a major low is usually driven by short-covering. The entire rally from $29.85 to $40.32 is likely being driven mostly by short-covering with a sprinkling of momentum buying by speculators like commodity funds.

The next move down is usually fueled by new short sellers. It is usually a 50% to 61.8% correction of the first rally. This would make $35.09 to $33.85 our primary downside target.

Professional traders rarely try to pick bottoms, but they do get aggressive on the long side after the first rally from a major bottom. If crude oil is bottoming then it has to break into a value zone like $35.09 to $33.85 in order to give the professionals a chance to get long at more favorable prices. Given the size of the supply and the uncertainty regarding a production freeze, there is not a professional out there who would consider buying strength or new highs in this current trading environment. However, they would be interested in buying the dips or value if presented with the opportunity.

Good rallies have one thing in common - a secondary higher bottom. We don't have one at this time so I still think the current rally is being driven by short-covering.

Just like professionals like to buy retracement zones, they also like to sell retracement zones especially if they are trading in the direction of the main trend. Since the trend is down, I expect to see sellers come in if the $40.74 to $43.31 zone is tested.

Based on this week's high at $40.32, it is possible that we may not see a test of the primary retracement zone. If this high sticks and the news turns bearish then look for a near-term pullback into $35.09 to $33.85. A test of this zone is probably going to be your best buying opportunity if you are an aggressive counter-trend trader.

Another item to note on the weekly chart is the main top at $51.63. Taking out this level will turn the main trend to up. However, it is too far from the bottom at $29.85 to buy a breakout over that level. Therefore, we have to see some kind of break that will bring the top down and give traders a lower entry point for a change in trend. If the market breaks for at least two weeks from $40.32 then the change in trend point will be lowered. This will be another sign that we care coming closer to the formation of a major bottom.