Drozd: Crude oil prices reach four-month high

Rectangles, or box formations as they are sometimes called, are frequently found on futures price charts. Sometimes they prove to be a continuation or sideways consolidation pattern following an obvious trend, indicating that the market is simply taking a breather before continuing its advance or decline. At other times box or rectangle formations can evolve into a legitimate trend reversal.

As a general rule, rectangles developing into a reversal pattern are most likely to occur after a downtrend, forming a bottom prior to the start of a new advance. This is the case with the accompanying crude oil chart. From a high of $147.27 in July 2008, crude prices plummeted down to a low of $32.48 in December 2008, and have been trading in a sideways range ever since.

However, this is about to change, as prices recently pushed through resistance, which was the upper boundary of the rectangle indicating that this market has bottomed and is about to turn higher.

A rectangle formation consists of a trading range which is bounded on both the top and bottom by horizontal lines. Within this range, the price fluctuations must form at least two tops and bottoms. The pattern is completed when the price exceeds either the upper or lower boundary. A breakout from a rectangular pattern is considered to be a highly reliable forecasting tool.

Within the rectangle seen in the accompanying chart crude oil prices were range bound between $33 and $49. A minimum objective can be determined by measuring the vertical distance of the rectangle, and projecting it at the point of breakout. Using this measurement, an upside objective of $65 could be expected.

Although prices have turned up past resistance at $49, this market is technically overbought on the daily charts and vulnerable to a minor downward correction. With rectangles, prices will often exceed the formation’s boundary only to return to the pattern before moving in the direction of the original breakout.

A 50 per cent Fibonacci retracement would take prices back up to $90 per barrel.

Market psychology

Since the rectangle basically outlines a trading range, the buying and selling behaviour that comprises this pattern denotes support and resistance levels within the current price trend. The upper horizontal boundary begins to form due to profit-taking by longs, which means they are now selling and this turns prices lower. As the market declines, it attracts bargain hunters. The lower boundary represents a line of support where the demand, or buying of contracts, exceeds the supply, as evidenced in the chart with each additional low being slightly higher than the previous.

Similarly, the upper boundary represents a line of resistance where the supply of contracts for sale exceeds the demand, or buying of contracts. Between these two extremes the market is in relative balance, with neither buyers nor sellers able to gain a lasting advantage. Prices remain trendless for a time until either the buying at the upper boundary exceeds the selling, or the selling at the lower boundary exceeds the buying. When either occurs the scales are tipped and prices break out of the formation.

A breakout through the upper boundary not only cleans out the supply of contracts that had previously halted the advance, but it puts all shorts into a losing position.

Similarly, when prices break through the lower boundary of a rectangle all longs are placed on the defensive. To understand where on a chart the anxiety level of shorts or longs increases is very useful, for it is shortly thereafter that their contracts become fuel for the fire.

A rising crude oil market lends support to the grain and oilseed markets and to the Canadian dollar.

Join me online for an audio-visual presentation about this article and chart.

— David Drozd is president and senior market analyst for Winnipeg-based Ag-Chieve Corporation. The opinions expressed are those of the writer and are solely intended to assist readers with a better understanding of technical analysis
in the markets influencing agriculture. The information contained herein is deemed to be from sources that are reliable, but its accuracy cannot be guaranteed. Visit us online for more educational tools and ideas about grain marketing, or call toll free 1-888-274-3138.

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