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Itís been a while since Iíve written about Crude Oil here on the blog. Itís a topic that has been coming up more often recently as prices are hitting levels not seen in over 6 years. Just because something is in the news a lot doesnít mean it is a market that is worth our participation. In fact, more often than not, if itís all over the news, you probably either missed it, or youíre too early. We have preferred to stay away from Crude Oil since it broke the uptrend line from the March lows. This occurred in mid-May after a 30% rally in Crude Oil that was sparked from the failed breakdown and bullish momentum divergence that we were pointing to in March. This worked out well the first time around and now I believe we are about to see something similar.
Technical analysis is not an exact science. For that matter, any form of market analysis is subjective and can be better categorized as an art, even fundamental analysis. There are no perfect right or wrong answers. By definition, no one knows what will happen in the future. Today I think I can provide a good example of a subjective approach to a market that may or may not work, but at least there is a risk vs reward opportunity that is skewed towards one side. In a similar way to how in March, we did not know whether Oil prices could climb back above the January lows (although we hoped for it), today we do not know if Oil prices can climb back above $43 to trigger another entry point for us. Let me explain.
Here is a daily candlestick chart of Crude Oil futures breaking down to lows not seen since 2009. There are a few things going on here that I think are worth pointing out. First of all, prices have now come down to the downtrend line connecting troughs since those January lows. There are multiple downtrend lines here because both make sense. We therefore look at this as more of a support ďareaĒ, than an exact point. In addition, we are just below the 161.8% Fibonacci extension of the January rally. Remember this January bounce is the reason we liked it in March in the first place. So we will continue to refer to this move going forward as the most relevant move.
Again, this is an art and not an exact science. Maybe the market will roll over again and not bottom out until prices reach fibonacci extension levels based on the entire March-May rally. We have no idea. But the weight-of-the-evidence is suggesting that this area near $41.50-43 is worth watching as a possible entry for a mean reversion.
In addition, sentiment has now come down to levels not seen since December of 2001. If you recall, this was when Oil bottomed out after peaking in the Fall of 2000 just before it rallied from $17 towards $150. Our sentiment data suggests we are at a similar bearish consensus (via SentimentTrader.com).
From an execution standpoint, I think itís pretty simple. Based on this $43 level representing the 161.8% Fibonacci extension of that key January rally, I do not see any reason to be long Crude Oil if we are below that. This is our line in the sand. If prices are above that, then I can make an argument to be aggressively long only above $43. Since those January lows were such an important support level, I would expect there to be some sort of reaction upon retesting that price. This overhead supply should become resistance on any strength towards that area. Notice how in late July after breaking those January lows, prices bounced off the March lows, retested the January lows, and then rolled over again. This reiterates to us how important $49.50 is going forward. From a tactical perspective I would be a seller of strength into that price. This represents about 15% of upside near term with very well-defined risk (only long above 43).
If prices are able to get back and hold above $49.50 then I can see potential for more mean reversion towards the downward sloping 200 day moving average and former support that broke in June near the high 50s. But I donít see any sense in worrying about that at this point. I would rather wait and make those decisions if and when we ever get up there.
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