Was That The Bottom In Oil?

“Was that the bottom?” is the question most market participants are asking regarding Crude Oil, and the energy markets as a whole, after today’s steep rally. I have no idea if this is a bottom or not, but what I do know is that, from a risk management perspective, the risk/reward has not been better for the bulls in months. At the end I’ll reiterate my bottom line in more detail, but for now I’ll walk you through the information I’m looking at and allow you to make your own conclusions.

First off, let’s see what has happened other times in history when crude has rallied 10% or more in one day. As you can see from the data below, the average returns are less than stellar in the short term, but improve as you look out a year. For a swing trader looking to catch a bounce, this backdrop is not exactly encouraging, but is just one of many pieces of evidence.

Excel Chart

Excel ChartFrom a public sentiment perspective, my data suggests that we’ve not seen this level of pessimism in the Oil market since 2002 and commercial hedgers are positioned the same way they were in mid-March of this year before prices rallied sharply. Also, prices have ignored the bullish seasonal tendencies of the summer thus far, but that positive seasonal tailwind remains intact throughout September.

Given the mixed signals we’re getting from our historical data, sentiment, and seasonality, let’s take a look at price to see if we can get a clearer picture.

chartFrom a structural perspective, there’s no doubt that Crude Oil is in a long-term downtrend. Given that context, we’ve just bounced off the 161.8% extension of the ’10-’11 rally as momentum put in a higher low. With prices back near the ’09 low, we’ll have to see if this demand can continue and push prices back above the broken uptrend line drawn from the ’03 and ’09 lows. That being said, these conditions do look decent to spark a mean reversion if the other timeframes agree.

chartOn the daily chart, momentum remains in a bearish range and did not diverge at the recent lows, but price put in a false breakdown below trendline support. With prices roughly 35% below the 200 day moving average I think we can definitely see mean reversion to the upside, with today being the catalyst to spark that move.

chart 2On the hourly chart, we can see that price has been firmly below a downward sloping 200 hour moving average since late June. Recently prices broke out above that level and are now testing a big trendline resistance with momentum solidly hitting overbought conditions. The 200 hour simple moving average is now flattening out and starting to rise, which I think is a major tailwind for higher prices going forward.

chartThe above chart shows the same hourly chart zoomed in to highlight some of the key levels in the short term. If prices can consolidate between 42 and 43.25, I think that’d be really constructive and set us up for higher prices. If prices were to correct through time, I think that 39.75-40.50 is the range to watch for buyers to get step in.

The Bottom Line: No, the stars aren’t perfectly aligned for Oil to move higher, but this is the best it’s looked on the long side in a long time. In terms of positives, price action action and momentum have improved on multiple timeframes and the 200 hour simple moving average is now a major tailwind for prices to move higher. This combined with prices being 35% below their 200 day simple moving average and sentiment at 13 year lows, makes for one heck of a mean reversion setup. On the negative side, historical data suggests short term returns after these rallies are lackluster at best and price has ignored bullish seasonal tendencies up until this point, so who am I to suggest that will change overnight? Additionally, I don’t like that prices in other energy related markets have not been leading to the upside like they had been prior to the Crude Oil rally in March.

Overall, I think from a risk management perspective this is the best shot on the long side that the bulls have seen in months. Ideally, prices could set up again by consolidating between 42 and 43.25, but if we do pullback I’d like to see the 39.75-40.50 range hold. As long as the 200 hour simple moving average is rising and prices are above 40, I think we see this mean reversion toward the 200 day continue.

As always, if you have any questions feel free to reach out and I’ll get back to you as soon as I can.