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Crude Oil - Here is How to Play the Breakout

Crude Oil - Here is How to Play the Breakout

2014-02-10 19:20:00
Research, Research Team
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A strong end to the week saw crude oil prices break significant resistance; what are the levels to watch?

Key Takeaways:

  • Demand for oil is high due to cold weather.
  • Crude prices recently broke out of a four-hour ascending triangle, indicating upside potential.
  • Crude oil is currently overbought, so it might be due for a short-term correction.
  • Crude oil price is approaching an area of longer-term resistance.

From highs of around $112 per barrel during August last year, the price of crude oil dropped substantially throughout the latter half of 2013 to end of November lows at 91.74. A small rally saw crude oil prices regain some strength, with a bounce from lows to just above the 100.00 flat level. However, this rally preceded another decline that took the price of oil to January lows at 91.21. Since this decline, price has once again rallied, just about reaching the heights of the previous bounce. What do the charts tell us about this rally and, more importantly, what clues can price action offer about the likely future direction of crude oil?

Crude Oil Prices - 4 Hour Chart

crude-oil-news-how-to-play-breakout-0004_body_Image6.jpg, Crude Oil - Here is How to Play the Breakout

First, take a look at the four hour chart above. Between January 27th and February 7th, crude oil prices formed something of an ascending triangle, with a gently sloping lower channel and an upper resistance line around 98.31-98.42. An ascending triangle in an uptrend is often a sign that the uptrend will likely continue after a period of consolidation, as the higher lows suggest increasing demand for an asset. Friday's price action saw a rally, primarily driven by positive labor statistics and cold weather, since cold weather creates demand for heating oil and, in turn, high refinery demand for crude oil.

The rally caused a break above the upper resistance channel and out of the triangle, validating the pattern. Crude prices then closed above resistance for two consecutive sessions, further strengthening the upside bias. However, one thing to bear in mind is that the price of oil may temporarily correct to the downside. The commodity channel index (CCI) indicator currently reads 217; anything above the 100 level normally indicates an overbought asset. Therefore, expect a downside correction, perhaps even as far as the broken resistance line, before the medium term upwards trend resumes.

crude-oil-news-how-to-play-breakout-0004_body_Image7.jpg, Crude Oil - Here is How to Play the Breakout

Now take a look at the daily crude oil price chart. From this perspective, you can see price is just about at an area of longer term resistance, between approximately 100.00 flat and 101.00. This level of resistance also coincides with the 50% Fibonacci retracement of the September 2013 high and the January 2014 low. Price action round this resistance will be a key determinant of the longer-term trend. If crude oil prices break and close above 101.00, expect further rises. Key levels to watch in this bullish scenario will be 103.20-103.30 initially, as this level represents the 61.8% Fibonacci retracement, and beyond that, previous resistance/support between 103.65 and 104.00 flat.

If, on the other hand, oil prices fail to break the 101.00 resistance level, this could indicate a downside reversal similar to that at the end of December last year. In this bearish scenario, the primary target would be 100.00 flat, simply because it is a strong psychological level. Beyond flat, initial targets would be 98.65, the 38.2% retracement of the aforementioned Fibonacci, and 96.00-96.50 area of previous support. All said, the longer term direction of crude oil will likely be determined by fundamentals rather than technicals, but by keeping an eye on the key levels mentioned in this piece you can gain some idea as to the short-medium term fluctuations, and in turn, the targets they infer.

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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