Trading position (short-term; our opinion): Short positions with a stop-loss order at $65.23 are justified from the risk/reward perspective.

On Wednesday, crude oil moved higher after the market’s open supported by the bullish EIA data, but the commodity reversed as the IEA report weighed on investors’ sentiment. As a result, light crude lost 1.78% and slipped to $60. Will we see lower values of the commodity in the coming days?

Yesterday, the U.S. Energy Information Administration reported that U.S. crude oil inventories fell by 2.19 million barrels in the week ended May 8, compared to forecast for an increase of 0.3 million barrels. Thanks to this bullish report and a weaker greenback crude oil extended Tuesday’s rally and climbed to an intraday high of $61.85.

Despite this improvement, light crude reversed as the International Energy Agency raised its forecast of 2015 non-OPEC production growth by 200,000 barrels a day to 830,000 barrels a day. In its monthly report, the IEA also showed that Russia’s output jumped an unexpected 185,000 barrels a day year-on-year in the previous month, Brazilian production was up 17% in the first quarter, while production in China, Vietnam and Malaysia has also shown persistently strong growth. In these circumstances, light crude declined and slipped to $60. Will we see lower values of the commodity in the coming days? (charts courtesy of http://stockcharts.com).

Quoting our previous Oil Trading Alert:

(…) yesterday’s upward move took crude oil to the key resistance zone (created by the 200-month moving average and the long-term blue line) once again. Earlier this month, this solid resistance area stopped further rally, triggering a pullback. Taking this fact into account, we think that history will repeat itself and we’ll see another drop in the coming day(s).

Looking at the long-term chart, we see that the situation developed in line with the above scenario and crude oil declined below these key resistance levels. This is a negative signal, which suggests that further deterioration is just around the corner.

Having said that, let’s take a closer look at the daily chart and find out what impact did this downswing have on the very short-term picture.

From this perspective, we see that although crude oil moved higher after the market’s open, the red resistance line (the lower border of the rising wedge) stopped further rally, triggering a pullback to $60. In this way, the commodity verified earlier breakdown below this resistance, which suggests that the right shoulder of a bearish head and shoulders formation is underway.

Additionally, the size of volume that accompanied yesterday’s downswing suggests that oil bears are getting stronger. Taking all the above into account, and combining it with the long-term picture, we think that our last commentary is up-to-date:

(…) we can notice a potential head and shoulders formation. If this is the case, and oil bears take advantage of this opportunity, light crude will extend declines and test the strength of the green support zone (created by the Feb highs around $54-$54.24) in the coming days (please note that in this area the size of the downswing will correspond to the height of the formation).

Nevertheless, before we see such price action, crude oil could increase from here (…), which would build the right shoulder of the formation. On top of that, oil bears will have to push the commodity below the green support line based on the May lows (the neck line of the formation is currently around $58.14) before we see an acceleration of the decline.

Summing up, although crude oil moved higher after the market’s open, the solid resistance zone created by the 200-month moving average, the long-term blue line and the lower border of the rising wedge (marked on the daily chart) stopped further improvement, triggering a pullback and creating the right shoulder of a bearish formation. All the above, provides us with bearish implications and suggests that another downward move is just around the corner.

Very short-term outlook: bearish
Short-term outlook: bearish
MT outlook: mixed with bearish bias
LT outlook: mixed with bearish bias

Trading position (short-term; our opinion): Short positions with a stop-loss order at $65.23 are justified from the risk/reward perspective. We will keep you – our subscribers – informed should anything change.

Thank you.

Nadia Simmons
Forex & Oil Trading Strategist
Przemyslaw Radomski, CFA
Founder, Editor-in-chief

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