Though oil prices jumped 4 percent right after OPEC and friends announced last Friday that they would reduce production by 1.2 million barrels a day starting January 2019, skeptical markets gave back all those gains the very next trading day, on growing concerns that an economic slowdown will impact energy demand.
Investors may find themselves spread too thin, worrying about all the possible disasters in the current market environment: a day-to-day, up-and-down trade war between the world’s two largest economies; a vote of no confidence in UK PM Theresa May, exacerbating an already tenuous Brexit dynamic which threatens to disrupt the financial system in ways as yet unknown; a potential US government shutdown by a vindictive US president, who happens to also be under criminal investigation; as well as economic slowdowns in China and Germany, with recent signals indicating that the US may be on a similar course.
If the above list of market worries makes readers flinch, that’s just a small taste of what traders go through daily in the current financial markets climate. And that’s before acknowledging that oil remains in a bear market, with the prevailing trend continuing lower.
As such, any rallies should be viewed as possible bull traps till proven otherwise, once a bona fide bottom has actually formed. Since November 21, the trading pattern has developed a pennant, bearish in a downtrend. Moreover, this pennant should be a no-brainer for traders, as it doesn’t even challenge the downtrend line since the October 3, $76.90 peak.
Additional indicators bolstering the bearish outlook: not only a Death Cross, but also a complete bearish formation for MAs which developed throughout the pattern. Indeed, each MA has fallen harder than the longer one, demonstrating the increasing decline.
If the price breaks downward with its prevailing trend, it will signal a resumption of the preceding decline, as all the demand above the psychological $50-level has been absorbed and desperate sellers keep compromising on price to find willing buyers, as they feel short-sellers breathing down their necks, pushing prices even lower. Since a pennant is a continuation pattern —a period in which earlier short-sellers take a breather while garnering profits, even as they second-guess their fears the market may have gotten ahead of itself, while new blood presumably comes in to pressure prices lower—it is expected to break to the downside, in line with the downtrend.
When that happens, it will signal that demand has been absorbed and that prices are therefore expected to keep falling. That would attract the older bears, whose self-doubt was dispelled by earlier profit taking, adding their weight to newer sellers who just joined the selloff. This dynamic would then be expected to repeat the price move lower, before the disruption from the October 3 peak of $76.90 to the November 23 low of $50.15, a whopping $17.80 plunge toward $32.35, for a heart-stopping slide of 38.5 percent.
Of course, we can’t know whether the pattern’s implied target will necessarily materialize. Still, with all the risks listed above, there’s plenty of combustible material to feed this fire. Plus, if anyone thinks such a move is impossible, we refer you to the 2014, $64, 60% plunge; or the additional $34, 56% drop that followed in the second half of 2015, taking prices to the bottom of $26.05, the lowest level for oil in almost 13 years.
Trading Strategies – Short Position Setup
Conservative traders should wait for a downside breakout whose penetration reaches below the November 29 low of $49.41, satisfying a 3-percent filter to avoid a bear trap, as well as posting a new trough in the downtrend. Then, they would wait for a return move, to retest the resistance of the pennant.
- Entry: $50, the round psychological number, after penetrating $49.41, the November 29 trough.
- Stop-loss: $51
- Risk: $1
- Target: $47
- Reward: $3
- Risk-Reward Ratio: 1:3
Moderate traders may short after a close below the $50 level, which would absorb demand at that psychological level, as well as include a 2-percent filter in reducing the risk of a whipsaw. Then, they could wait for a return move to reduce exposure, but not necessarily for proof of the downtrend’s integrity.
- Entry: $51, after closing below $50
- Stop-loss: $52
- Risk: $1
- Target: $46, above the August 27 trough
- Reward: $5
- Risk-Reward Ratio: 1:5
Aggressive traders could short now, relying on the resistance of the pennant top.
- Entry: $53
- Stop-loss: $53.50, above the pennant top
- Risk: $0.50
- Target: $51, pattern bottom
- Reward: $2.00
- Risk-Reward Ratio: 1:4