Urging Caution on Oil

 | Jul 08, 2013 | 9:00 AM EDT
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Did you miss the rally in oil over the past two weeks? Perhaps it has only just now caught your eye as oil-related stocks dominate your gainers lists? If that's the case, I must now urge caution.

Oil made a rather pivotal move this month. Thanks to last week's rally, for the first time in over a year it is now trading above its 20-month moving average. Moreover, the weekly triangle it had been trapped in throughout that entire time finally broke as well. That triangle was responsible for a particularly difficult May for short-term traders still pressing their luck.

In the final stages of a triangle formation it is common for false breakouts to reverse quickly, which we experienced in April when it appeared that the bears had gained the upper hand. But the rapid retracement to the upside off daily support in mid-April proved that the battle was not yet over. Throughout May the bears began to lose the fight. An inverse head-and-shoulders pattern developed on the daily and weekly time frames as prices hugged the monthly 20-day MA and the upper end of the larger triangle. The final technical boost for oil took place when this strategy triggered last month and was confirmed this past week. 


United States Oil (USO) -- Daily Chart 1
Source: TradeStation


As we enter a new trading week, oil is looking exhausted. The rally over the past two weeks was at the upper limits of a typical multi-day run and it will rarely push further without first pausing to catch its breath. One of the best comparisons one can make on a breakout move in a security is to compare the current move to past price action. In this case, the last rally took place at the end of April. As we compare the current rally to April's rally, we can see that there is nearly a 100% expansion on the daily time frame. Yes, there is a little bit of room left, and the momentum on the current rally is a bit stronger than the one in April, giving it a greater chance to push slightly past that exact 100% expansion. But the fact remains that this major exhaustion zone is now being hit.


United States Oil (USO) -- Daily Chart 2
Source: TradeStation


Oil also has some major resistance on the weekly chart that it will likely struggle with initially as well. These include the highs from last fall, as well as multiple pivot points throughout 2011. Last September's high also corresponds to the 61.8% Fibonacci retracement level from the downtrend move that took place throughout the second quarter of 2012.


United States Oil (USO) -- Weekly Chart 1
Source: TradeStation


Due to the rapid upside momentum oil has experienced over the past two weeks, it is unlikely that we will see any strong price retracement off these resistance levels. Even if a rapid flush does occur, the odds are strong that the highs would be retested very quickly. Instead, I am anticipating a slowdown from buyers and a correction more through time than price. This will create a more difficult market for swing and position traders due to greater overlap in prices from one week to the next while a correction plays out. For the longer-term bulls to maintain the upper hand, I would actually like to see some slightly higher highs take place in the week ahead, but as a swing trader or position trader, the ideal entry opportunity for this move has passed and it is now the realm of the shorter-term trader.


United States Oil -- Weekly Chart 2
Source: TradeStation


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