Drozd: Main trend in crude oil still up, despite recent downturn

Crude oil prices have been under pressure since a two-week reversal developed 12 weeks ago. This reversal pattern materialized after crude oil prices failed to exceed the upper boundary of the uptrending channel.

A two-week reversal indicates a change in direction and can occur at the top or bottom of a market. This two-week reversal signaled an end to the rally.

The two-week reversal identifies a shift in market perception. At first, the longs are content with their positions, as the market settles higher and adds reassurance of greater profits.

However, the following week’s activity proves to be discouraging to the traders who are still long the market. It’s a complete turnaround from the preceding week, as prices turn down and cast doubt on the expectation for higher prices. The longs respond to weakening prices by exiting the market. Some sell to take profit and others sell to cut their losses.

Despite crude oil’s $25 per barrel drop in price, the major trend is still up as defined by the uptrending channel in the accompanying chart.

Channels

In a rising market, a trendline is drawn across at least three points of price contact, each of which coincides with the low of a market reaction. These price reactions must bottom at progressively higher levels.

In an uptrend, the uptrend line is the channel’s lower boundary. The upper boundary, the return line, is parallel and drawn across the highs of each progressively higher advance. The return line points out the areas where reactions to the trend are likely to begin. The uptrend line is constructed first.

The corridor, within which prices will fluctuate as the trend proceeds, is called the trend channel. The price action doesn’t always make it possible to construct a well-defined and compact channel, but when it does, it is extremely helpful for studying the trend.

Market psychology: Price activity that lends itself to trendline and channel construction reflects a particular sequence of behaviour. As a new uptrend begins to emerge, buy orders materialize, but many are at a limit price under the market. In the normal ebb and flow of the market some of this buying is satisfied on price declines. However, a portion of the demand is not satisfied and when prices again begin to move up, some of these buyers jump in for fear of missing the move. The balance of unfilled buying will continue to trail the market in hopes of catching a price reaction. Most of these buyers will gradually increase their bids as the market advances.

Some profit-taking and short selling will emerge as the market rallies to new highs. This results in an increase of potential buyers, as well as of shorts eager to take profits during periods of price retrenchment, preventing remaining “buy” orders that are too far under the market from being satisfied.

In an uptrend, the market rallies and then reacts to uncover underlying support. This process, once set in motion, develops a momentum which strengthens the trend and makes it persist. After a period of upward movement, one must be on the alert for any subtle changes in this repetitive process as they will show up clearly on the price charts.

The crude oil market is beginning to turn up from the lower boundary of the uptrending channel. Just as a two-week reversal indicated prices would turn down three months ago, another two-week reversal, indicating prices are about to turn back up, could materialize on July 1, if prices have a weekly close above $91.97.

The main trend is up as long as prices remain confined within the uptrending channel. However, a decisive close under $89 a barrel could spark a long liquidation break.

Send your questions or comments about this article and chart to [email protected].

— David Drozd is president and senior market analyst for Winnipeg-based Ag-Chieve Corp. The opinions expressed are those of the writer and are solely intended to assist readers with a better understanding of technical analysis. Visit Ag-Chieve online for information about grain marketing advisory services, or call us toll-free at 1-888-274-3138 for a free consultation.

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