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January 2, 2016

Technical Analysis of the Oil Market

By EconMatters

Negative 2015

The oil futures market was down around 30% in 2015 depending upon which contract you look at, and provided some nice trading setups both from the long and short side this past year. 2015 was characterized by starting the year off with new money coming into the market from the short side trying to push prices lower in order to establish a bottom before running them up into the heart of the winter heating season, and the subsequent summer driving season.

Oil prices peaked in early May with straight selling into late August as the front-running the end of the summer driving season reached an exhaustion phase, and the big 6 days of short covering/squeeze closed out the month of August in the commodity. After a six dollar retracement traders put in a near term double top for the second half of the year on middle east tensions revolving around the conflict in Syria before getting smashed into year-end establishing a new low on building inventories, mild weather, and shorts pressing their positions.

2016 Market Outlook

Therefore, what do the charts tell us about the market for 2016? Where are the key technical levels in the commodity? And what represents a trading opportunity in the space? On a very short term basis we have been stuck between $36 and $38 for the bulk of the trading the last two weeks of the year with nobody wanting to initiate substantial new positions into year-end.

The obvious short term trade here is to play this breakout as new money will come into the oil market at the beginning of the year. The question is just whether the new money is going to come from the short side or the long side? The last several years the beginning of the year has consisted of an early slam down to clear out the weak hands and then make some money taking it higher, a common trading technique. But one doesn`t need to guess with such a tight trading range, the market will let the trader know real quick which side this new money coming into the market is on.

February Futures Contract

Therefore, in looking at the February Futures contract a break above $38.30 should be bought with a protective stop at $37 or $38 depending upon your trading style. And conversely a break below $36.22 should be sold with a protective stop around $37 or $38, pick an exact point by dialing in on your trading chart where you determine the trade becomes invalidated against your position. Then see if a direction gains some traction as we may just bounce around here a bit being at such low levels between support and resistance. This is why I would move my stop up aggressively to protect profits and or trade around a core position where I want to take a longer term swing trade. Keep abreast of any fundamental changes like 10 million weekly inventory builds, or large drops in US Production as potential catalysts for a sustained trend one way or the other in 2016.

Overhead Resistance Levels

On the upside the next level of overhead resistance is $42 a barrel in the February contract. A break above $42 means that the $46 a barrel level is in play, and keep abreast of a short squeeze, as if we break $46 with conviction the $50 price can be hit at the drop of a hat. If you don`t believe me just refer back to last August`s short covering rally. There is solid overhead resistance at $52 a barrel, and there would have to be some catalyst at work to bust through this level early in the first quarter of 2016. Like US Production dropping to 8.7 million barrels per day from roughly 9.2 million barrels per day. It doesn`t matter so much about current oil inventories as markets are anticipatory in nature.

The binary nature about markets should be realized here as a break above $52 probably means we are going to $60 a barrel as money is either coming into the market from the long side or not, there is no in-between, only shorts to be crushed trying to step in the way of these money flows, which only exacerbates and accelerates the move to the $60 level.

It doesn`t matter what some analyst thinks the fundamentals say regarding what is a fair value for the price of oil, it doesn`t matter what makes sense at the end of the day over the longer term. What matters is that in actuality it takes very little to move the price of oil from $38 to $60 a barrel, especially given the current directional short bias in the commodity in what has and is traditionally a long oriented market. Once money starts coming into the market from the long side all bets are off regarding ‘reasonable’ value-oriented price targets.

Something has definitely changed in the oil market if we break above the $62-$64 trading area as that is essentially the line in the sand between the old oil market and the new lower for longer oil market of 2015. We are a long way from worrying about those prices right now so I will stop there with discussing overhead resistance areas of note.

Downside Support Levels

Now to the downside, the dark Goldman Sachs and many others on the street doomsday scenario for oil prices. If we break $36 a barrel to the downside in a retest of the around $35 on the February contract lows, $35.35 to be exact - we went into the $34s on the front month futures contract at the time. Then just let it ride if you are in this trade to the downside, moving your protective stop up at definite trade invalidation levels of resistance on each leg lower down in the commodity. There is the $32 and change to $33 level that occurred during the 2007/08 financial crisis lows which we will call the $33.20 price on the February contract. But a close below $33 a barrel will be interesting to see if and when buyers step in? Can we make a run into the high 20`s? Maybe $29 or $28.85 a barrel? I would think that there would be other catalysts in the financial markets like a combination of drivers to not have buyers step in at these levels.

The only way we should go substantially below $28 a barrel is if there is a major China growth scare, a Credit Event causing risk off in all asset classes, and an Equities Selloff where traders just step aside from the market to let prices clear before deciding it really isn`t the end of the world. Maybe a short term Inventory Storage Event could also cause this magnitude of a downside price break below $28 a barrel.

In actuality if oil is smashed to $20 a barrel this probably is a bullish driver for oil prices going forward, as the losses created by this price disruption would mean much oil production and businesses are permanently offline, and out of business for good. Just because oil prices recover, if a business loses its shirt at $20 a barrel, they aren`t coming back to the market anytime soon. They are effectively financed out of the market by more prudent lenders and investors who have a higher lending threshold or standard going forward because they price the $20 oil scenario into any new model going forward for project evaluation and approval.

Follow the Price Action

And of course, when buying oil off the bottom if a new low is established just follow the price action levels, as they will tell you where the direction has changed, and the low is in fact in place for the oil market for 2016.

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Item Reviewed: Technical Analysis of the Oil Market Rating: 5 Reviewed By: EconMatters