The continued rally in crude oil since October has taken prices to an overbought level, which can result in a reversal in prices. It's time for investors long on crude oil to book profits and for bears to initiate short positions.
One of the reasons attributed to the rally in oil is the possibility of a US or Israeli strike on Iran's nuclear facilities. Such an action could disrupt oil supplies from the Middle East, at least temporarily, and if Iran chooses to retaliate, the disruptions would last longer.
These fears naturally pushed the price of crude oil higher. Such a strong rally is especially bad for an oil-thirsty India. The rise in crude prices could not only increase the already high inflationary pressures in the Indian economy but also push the weak rupee lower.
However, the accompanying chart below suggests that crude is expected to fall lower once it hits the US $99-102 range. The prices of crude closed at $98.99 on Friday. We are looking at the weekly chart of crude oil continuous contract on Nymex.
The range between $99 and $102 has acted as support and resistance in the past. Also, a textbook rule for chartists is that past areas of support turn to resistance and vice-versa.
If you look at the chart from left to right across the two white horizontal lines you'll notice the importance of the level. The two white horizontal lines demarcate the area between $99 and $102. On the left of the chart there are red arrows showing how prices hit the level and then fell, clearly indicating that sellers exceeded buyers. Areas where sellers exceed buyers are called resistance levels.
In the chart, prices break above the level to later fall back to the level shown by the left yellow arrows. Once prices fall back to previous resistance levels they act as support, which leads to a rally. Then the prices fall back to it again - as shown by the yellow arrows on the right. Prices move sideways as they are at support and then fall.
After a few weeks prices rally again to the previous support, which has now become the resistance that results in a huge selloff. The area from where the selloff occurred is shown by the red arrows on the right of the chart.
Notice that prices are back to the level from where crude oil sold off the last time and was also the resistance level in late 2010. They say that prices have memory and often recur as they did in the past. This means there is a high likelihood that crude oil prices may turn lower.
There is also another reason that crude prices may fall. Look at the commodity channel index (CCI) at the bottom of the chart. CCI shows if an asset is overbought or oversold. Readings above a positive 100 are treated as overbought and under a negative 100 as oversold. Right now the CCI reading on the weekly chart is a positive 194.70, which means highly overbought.
There is a lot of news about Iran and Europe that is said to be positive for oil prices. But objective price watchers will surely know now is not the time to buy but sell. If prices continue to rally above our resistance level we'd give up the bearish bias. Just keep in mind that even above $102 all way to $106 there is still selling pressure.
George Albert is Editor www.capturetrends.com
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