This year, being an oil bear has meant finding a large helping of foot in your mouth on a daily basis. A lot of oil analysts have been wrong about the oil price this month. It hasn't pulled back. Oil exploded to US$135 just days ago. That has left many with a bunion aftertaste.
An oil shock is undoubtedly here. It may turn out to be "the" oil shock, or it may not. Either way there's a lot you have to take in as an energy investor. Oil is breaking new ground each time it gains. We haven't been here before. Not many analysts understand exactly what is going on.
However, the laws of supply and demand still apply. There are still buyers and sellers. Read on for a clearer view of what you're dealing with. Now may not be the time to go chasing high-priced oil companies, an oil price correction could be on the horizon.
The trend is your friend until it ends.
There could not be a more important maxim of technical analysis. We don't know who said it first, but they were right. Every trend eventually ends. Every bull market corrects.
We're not looking for the end of the overall trend here, but a price consolidation. A minor trend that goes against the major one. Where does this current price explosion cease? And where will the minor trend take us?
In other words, when will oil consolidate, and by how much?
If a broker's report could tell you that, I'd be out of a job. Thankfully, there are some issues that fundamental analysis is hazy on. The chart should provide a bit of wisdom here.
There are three pretty well-defined points of support for oil. Each was established by a previous high. You'll note the long-term support level of US$83 stretches all the way back to 2005. It's the most well-tested, and the strongest buying point if oil comes back that far.
The other two are fair buying targets, although not as bullish as US$83. A level of support at US$110 will be the first place that traders move back into the market. If they get run over by sellers there, watch for a rally at US$98.
As for the when? Well, the answer is: any time now. There has been a common misunderstanding that the oil price should have corrected a long time ago, at US$110 for example. We can't help but disagree. Only now are the technical indicators finally beginning to show some cracks in the trend.
Firstly, oscillators indicate that oil has sailed into overbought waters. The MACD on the chart above is at an all-time high. Watch for it to turn around. That would confirm a turnaround of sentiment in oil.
But here's a little industry secret...traders won't be selling until the MACD line moves below zero. Such a movement tells them that the short-term average has dropped below the long-term average for oil's price. That's the selling signal sellers are waiting for.
We rarely settle for a single indicator though. The MACD gives us a taste of what's yet to come, but we're not full yet.
That brings us to the Ultimate Oscillator. This vital chart, second from the bottom, has often been a great relief to many oscillator traders. It smoothes out the volatility in other oscillating indicators, leaving you with a raw signal that can't be ignored. It tells when other prices indicators are lying.
Consider the bullish trend started in end of March until now. Oil prices recently posted a higher high (on May 21 above $134). But today there's a bearish divergence in the Ultimate. This divergence argues for a coming retracement. It overrides other methods.
Not enough for you? Well, the RSI and Stochastic oscillators also indicate that the prices are overbought.
Broadly speaking, a lot of bearish signals are flashing...or soon will be. The market is truly ready for a healthy oil price correction. You know where the buying points are. Now it's just a matter of time before the correction takes place.
Gabriel Andre
for The Daily Reckoning Australia
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About the Author
A former Futures and FX trader/portfolio manager, Gabriel Andre has worked in several hedge funds and asset management firms, both in Europe and Australia. He is a contributing editor to both Diggers & Drillers and the Australian Small Cap Investigator.
Comment by GaryB on 19 June 2008:
The irresponsible US Fed can bring down the price of oil and other commodities anytime they like, by raising their absurdly low cash rate from 2%, which will see the US dollar up and oil down. It's not rocket science. Or even complex graph analysis.
Comment by Charles Perry on 17 October 2008:
So at $69 and falling do you have any other clever suggestions?