Oil is back and is back strong. After an almost 60% decline in only a few months, oil seems to have stabilized and might have finally found a bottom. This is excellent news for bottom fishers who have been speculating about this event for several months now. Finding a bottom however is not an easy task. Remember we’re not trying to buy at the absolute lowest price as this is impossible. Instead, we want to buy after a bottom reversal pattern has been completed and then hold on as the security moves higher. The following chart shows one of the most common reversal patterns taking shape in the price of oil – the double bottom formation.
This pattern is a clear illustration of a battle between buyers and sellers. The sellers are attempting to push the security further down but are facing support, which prevents the continuation of the downtrend. After this goes on a couple of times, the sellers in the market start to give up or dry up, and the buyers start to take a hold of the security, sending it up into a new uptrend. An important criterion here is volume, which needs to expand upon breaking above resistance level.
Despite the fact that crude supplies remain at record levels, the outlook for oil is starting to improve as the number of U.S. rigs actively drilling continues to fall, supplies at the nation’s storage hub also dropped and new tensions in the Middle East raise concerns over the potential disruptions to global supplies. Furthermore the dollar’s retreat provided more support. The chart below shows the close correlation of the EURUSD pair (a rising pair corresponds to a weakening USD) to the commodity.
As expected oil stocks have benefited from the recent surge in oil. Since January when the absolute bottom for the sector was reached, the oil sector as measured by XLE (SPDR Select Sector ETF) is up by about 15% vs 6.5% for the S&P500. The chart below shows that oil-related stocks have also started to shape an uptrend by forming higher highs and higher lows, reversing the long term downtrend from September. Momentum for oil stocks has also turned bullish as the Relative Strength Index (RSI) crossed above 50.
Choosing where to invest in the sector is equally important. Low-cost exchange traded funds (ETFs) provide an excellent opportunity for those who would like to avoid the individual company risk but at the same time profit as the sector moves higher. Below we compare three different ETFs since January 15th where the absolute bottom was reached for the sector. Oil services and small caps stand out to have the strongest momentum.
After a prolonged decline, oil and oil related stocks seem to have finally found the strength to stand on their feet. Since last year they are in a much better shape. Price action, momentum and volume are all aligned to support the above but time will show. For the moment let’s enjoy their ride.
Costas Pierides CFTe MSTA
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