Trading position (short-term; our opinion): Short positions (with a stop-loss order at $35.63 and a price target at $25.63) are justified from the risk/reward perspective.
On Tuesday, crude oil lost 7.24% after a bearish IEA report. As a result, the commodity not only closed the day under the barrier of $30, but also approached the previous lows. Will we see a double bottom or further declines in the coming days?
Yesterday, IEA reported that oil stocks could rise by 2 million barrels per day in the first quarter, in spite of a recent rally. Additionally, the IEA also expects that inventories will remain relatively high in the second quarter, when production could increase by another 1.5 million bpd. Thanks to this bearish news, crude oil declined sharply and closed the day under the barrier of $30, but also approached the previous lows. Will we see a rebound from here or further declines in the coming days? Let’s examine charts and find out (charts courtesy of http://stockcharts.com).
Quoting our previous alert:
(…) we believe that as long as crude oil is trading under the key black resistance line and the neck line of the head and shoulders formation (marked on the weekly chart, which serves as the key medium-term resistance), lower values of the commodity are more likely than not. This pro-bearish scenario is also reinforced by the current position of the RSI, CCI and a sell signal generated by the Stochastic Oscillator.
On the daily chart, we see that although crude oil moved little higher after the market’s open, the upper border of the red declining trend channel stopped further improvement, triggering a pullback below the barrier of $30. This negative signal encouraged oil bears to act, which resulted in a sharp decline under the green support line. In this way, the commodity confirmed the head and shoulders formation, which suggests further declines in the coming days.
How low could light crude go? In our opinion, the first downside target would be around $25. Why here? We believe that the best answer to this question will be the quote from our Oil Trading Alert posted on Sep 4:
(…) Yes, it seems quite likely that crude oil will slide all the way down to more or less $25 dollars and there are multiple reasons for it:
- The breakdown below the key long-term rising support line (marked with blue) was confirmed and verified – this year’s rally didn’t take crude oil back above it – the line proved to be strong resistance. This by itself doesn’t imply a target level at a certain point, but it strongly suggests that crude oil has to fall much lower, before the decline is over.
- The symmetry of major declines: the 2008 slide is the only decline that is really similar to the current one, and in order for this similarity to be upheld (history repeats itself to a considerable extent), crude oil would have to move even a bit below $25. On the above chart you can see that in the form of the declining dashed black lines.
- The symmetry between the 2014 slide and the (likely) current decline. This year we have definitely seen some kind of consolidation (which might still turn out to be a bottom, but that is unlikely in our view) and the move that follows a consolidation is very often similar to the one that preceded it. If you look at the red dashed declining lines on the above chart you’ll notice that for the previous decline to repeat, crude oil would have to move to about $25.
- Speaking of the consolidation, it’s taking the form of a head-and-shoulders pattern and once / if the pattern is completed, we will have a pattern-based target at around $25. The reason is that once price breaks below the “neck level”, it’s likely to decline as much as the size of the “head” in the pattern.
- The late-2002 and 2003 bottoms create strong support at those levels.
The amount of signals that points to $25 as the most likely target is uncanny, which makes it quite reliable.
Nevertheless, taking into account the breakdown below the neck line of the bearish formation, we could see a drop even to around $23.68, where the size of the downward move will correspond to the height of the pattern.
Summing up, crude oil extended losses and approached the recent lows, which could encourage oil bulls to act and result in a rebound (even to the previously-broken neck line of the head and shoulders formation marked on the daily chart; currently around $29.73) later in the day. Nevertheless, as long as the key medium- and short-term resistance lines keeps gains in check lower values of the commodity are more likely than not. Therefore, we believe that short positions (which are already profitable as we opened then when crude oil was around $34) are justified from the risk/reward perspective.
Very short-term outlook: bearish
Short-term outlook: bearish
MT outlook: bearish
LT outlook: mixed with bearish bias
Trading position (short-term; our opinion): Short positions (with a stop-loss order at $35.63 and the price target at $25.63) are justified from the risk/reward perspective. The analogous levels for USO ETF and DWTI ETN are:
- USO initial target price: $6.67; USO stop-loss: $10.25
- DWTI initial target price: $513.31; DWTI stop-loss: $165.84
We will keep you – our subscribers – informed should anything change.
As a reminder – “initial target price” means exactly that – an “initial” one, it’s not a price level at which we suggest closing positions. If this becomes the case (like it did in the previous trade) we will refer to these levels as levels of exit orders (exactly as we’ve done previously). Stop-loss levels, however, are naturally not “initial”, but something that, in our opinion, might be entered as an order.
Since it is impossible to synchronize target prices and stop-loss levels for all the ETFs and ETNs with the main market that we provide this level for (crude oil), the stop-loss level and target price for popular ETN and ETF (among other: USO, DWTI, UWTI) are provided as supplementary, and not as “final”. This means that if a stop-loss or a target level is reached for any of the “additional instruments” (DWTI for instance), but not for the “main instrument” (crude oil in this case), we will view positions in both crude oil and DWTI as still open and the stop-loss for DWTI would have to be moved lower. On the other hand, if crude oil moves to a stop-loss level but DWTI doesn’t, then we will view both positions (in crude oil and DWTI) as closed. In other words, since it’s not possible to be 100% certain that each related instrument moves to a given level when the underlying instrument does, we can’t provide levels that would be binding. The levels that we do provide are our best estimate of the levels that will correspond to the levels in the underlying assets, but it will be the underlying assets that one will need to focus on regarding the sings pointing to closing a given position or keeping it open. We might adjust the levels in the “additional instruments” without adjusting the levels in the “main instruments”, which will simply mean that we have improved our estimation of these levels, not that we changed our outlook on the markets.
Thank you.
Nadia Simmons
Forex & Oil Trading Strategist
Przemyslaw Radomski, CFA
Founder, Editor-in-chief
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