If the fundamental outlook for oil prices has you confused, you’re in good company. We're confused too.
Recently, Saudi Arabia assumed a zero-risk strategy regarding output. The Kingdom has indicated it will not increase production until there's proof of demand. The Saudis even referred to the current lockdown in northern Italy when explaining their reasoning. Russia has also not increased production.
The International Energy Agency believes the oil market has peaked. The IEA does not expect demand to return to pre-COVID levels due to remote working and a shift to green energy. The agency considers current stockpiles to be sufficient for satisfying demand.
On the other hand, there are those who anticipate the price of the commodity will return toward the $100 level once lockdowns end.
We find the IEA’s approach nothing less than shocking, if we're honest, since just five weeks ago, the same agency declared that stockpiles were plunging “very, very sharply,” and—significantly—this occurred before OPEC stunned the world by saying that they will keep their pandemic production cuts in place. What gives?
Inventories have been rising for the last four weeks. However, the increase is negligible in the context of a reviving global economy where travel will again resume even if some continue to work from home.
How then to explain this flip-flop by the EIA, one of the world's most respected oil organizations? We can't. But the supply-demand balance on the technical charts is projecting that prices may be set to rise.
Notice that though news right now has been focusing on WTI falling for a fifth straight day—the longest dip for the commodity in a year, including amid the worst of the pandemic—even after the IEA's soft guidance on oil, the price has been supported by the $63.80 level, since it crossed above that on Mar. 5.
That price isn't random. It’s the previous high, posted Feb. 25. The fact that the previous resistance turned into support is telling.
It reveals a flip in expectations. Traders who had been selling learned their lesson and are now using that as a buying entry point.
Notice that before the price climbed above the $63.80 level on Mar. 4, it tried to do so a day earlier, reaching as high as $64.86 intraday, but closed at $63.83, right on the resistance. Since then, the price has fallen below the now-support of $63.80 three times: on Mar. 9, 10, and 17.
Nevertheless, in each instance it closed above that level. And, in today’s trading, the price touched the $63.80 level, to the penny, then rebounded to the $64 area.
But if it’s a forgone conclusion that the price has peaked and rising inventory will overwhelm demand per the IEA's projections, where is the demand we just described coming from?
Moreover, even if the price should fall below the $63.80 level, that doesn’t necessitate that the supply-demand balance will flip back to selling.
The price has been trading within a rising channel since the November bottom. It's now correcting due to profit taking, after having reached the top of the channel. That's not only expected but healthy. Prices often turn toward a channel bottom before then moving higher, a tested way of maintaining a sustainable rally.
Note, the corrective dip is crowded, attesting to a struggle between buyers and sellers, demonstrating equal forces. This in no way illustrates the slaughter of a selloff.
This congested range following the Three White Soldiers in early March—a bullish Japanese candlestick formation made up of three long candles (for the first time since May 2020) that tends to be the precursor for a longer rally—is the typical behavior of the falling flag pattern. The tight range is the product of lucky bulls who enjoyed the 8.75% ride after OPEC surprised by saying they’re keeping current production cuts in place, versus traders who are picking up the slack because they believe there is more to the move and are considering getting in on the a buying dip.
Trading Strategies – Long Position Setup
Conservative traders should wait for the upside breakout, then wait for a return-move to ascertain continued support, before committing.
Moderate traders could enter a position upon the breakout
Aggressive traders would enter a long with a close stop-loss, in case the 63.80 level holds, provided they understand the pattern did not yet complete and accept the higher risk of entering ahead of the rest of the market for a greater reward. Money management is crucial.
Here’s an example:
Trade Sample
- Entry: $64
- Stop-Loss: $63
- Risk: $1
- Target: $68
- Reward: $4
- Risk:Reward Ratio: 1:4
Author's Note: There are many ways to approach this trade. We expect a breakout to shoot the price past the $70 mark and then some, but that could entail a whipsaw. In trading, everything is a trade-off, between risk and reward, loss and opportunity. You must find what fits your budget, timing and temperament. Until you learn to do so, take small risks, for the purpose of learning, not profiting, or you won't learn nor will you profit.