Daryl Guppy

Differentiating oil rallies from trends

By Daryl Guppy (China Daily)
Updated: 2011-03-14 15:18

Knowing the distinction is vital for fuel-dependent firms such as airlines

A rally or a trend? The difference is crucial, particularly for airlines and logistics companies who are held hostage to world oil prices. The difference also helps to distinguish between the short-term and long-term impact of the devastating Japanese earthquake and tsunami destruction.

If the NYMEX West Texas Crude oil price spike to $105.44 is just a momentum rally then users can look forward to a rapid retreat in prices and a return to the broader stability that characterized the market between October 2009 and November 2010.

If the oil price is moving in an upward trend then any rally retreat remains part of a longer-term rising movement. This points the way to steadily increasing prices.

A rally is a fast upward move in prices. The fast move sometimes includes one or two days where there is a small retreat in prices. The slope of the rally is usually steep. The rally often ends with a very rapid collapse of prices to the long-term trend line.

The price move to $105.44 has all the features of a momentum-driven price spike and some of the features of a rally. A momentum price spike is an extreme and temporary reaction to significant events. It's a fast moving trading opportunity that is almost inevitably followed by a pullback to an underlying trend. This is closer to the situation on the oil chart.

These types of momentum spikes have a very loose relationship with the fundamentals of supply and demand. Oil producing countries have been quick to point out that they can more than make up for any losses in oil production in Libya. This in itself confirms the emotional momentum-driven component of the price spike.

The evidence for a longer- term upward trend in the oil price is confirmed with several features of the weekly oil chart.

The first and most important evidence of long term trending is the upward trend line. This starts with the August 2010 lows and uses the low in November. The strength and importance of the trend line was tested again in February 2011 when the price tested the trend line as a support level. The rebound developed strongly and confirmed the strength of a new upward trend line.

This confirmed the location of the trend line and it also confirmed the strength of the developing upward trend. This rebound confirmed oil had moved into a new upward-trending environment. The placement and significance of this trend line is confirmed with a third price retreat and rebound from the projected value of the trend line. This has not yet developed.

Related readings:  Higher oil prices threaten to become the new norm  Higher oil prices would hamper global economy  Japan quake, Middle East unrest hit shares across Asia  New energy is the key

A retreat to the trend line would see a drop in price to around $90 on current trend line values. This is a significant retreat from recent highs. While the oil price remains above the trend line then the upward trend is intact. A fall below $100 leads to a psychological sigh of relief, but from a technical chart perspective this level is not as significant as the value of the trend line near $90.

Any fall toward the trend line also has to fall below the key technical and psychological support levels between $98 and $100. The $100 level is a psychological resistance level when prices rise. It is a psychological support level when prices fall. The $98 level is the technical charting support and resistance level. Consolidation within this range of $98 to $100 followed by a rebound signals a much stronger and more sustainable bullish upward trend. This combination of technical and psychological levels creates a significant support area and price activity above $100 has a different behavior to the price activity below $100.

When price is above $100 the market develops more momentum behavior with more rapid up and down price moves. The oil price moves between support and resistance bands. When the price is below $100 the width of the bands is around $10. Above $100 the width of the bands increase to around $12. Above $100 the range of volatility increases. Weekly upward moves of more than $5 become common. Weekly down moves of $8 also become more common. The current retreat from $105.44 is part of this environment of increased volatility.

This upward trend behavior remains part of an upward sloping triangle pattern. This breakout fell just short of the calculated upside target near $108. The retreat and successful re-test of support levels and the upward trend line confirm upside targets of $112, $124 and, in the longer term, $136.

The Japanese earthquake reaction may create a temporary dip below the upward trend line. The end of the current upward trend is signaled with a close on the weekly chart below the upward trend line. This sets a downside target near $78 but this is a low probability result.

The author is a well-known international financial technical analysis expert.