When WTI crude oil prices breached $50/bbl back in June, it seemed like the march back to $60 was well underway. However, after topping $51/bbl, WTI made a sharp 180-degree turn and dipped back below $40/bbl by early August.
The step backward was disheartening for oil investors at the time, but WTI has once again reversed course in the past couple of weeks and surged back above $46/bbl.
What does the volatility of oil prices in recent weeks mean for oil investors? It may seem like the price of oil is all over the place, but this summer’s trading action has actually created some impressive symmetry in WTI’s chart.
One of the most common technical formations indicating that a stock or commodity has bottomed is the reverse head and shoulders pattern. The idea behind the pattern is that a stock will continue to make dips lower and lower until it ultimately makes its lowest dip. Once the stock begins its new uptrend, it will begin to form higher and higher dips.
The first higher dip of the new uptrend often reaches the level of the last higher dip of the previous downtrend. Together, the two dips form the shoulders of the reverse head and shoulders pattern.
Technical analysts know that perfectly-formed technical patterns are very rare. There’s a lot of noise involved in daily trading, and patterns often get a bit distorted. WTI’s reverse head and shoulders is a thing of beauty up to this point.
If you put a vertical mirror down the center of WTI’s double dip below $30/bbl in January and February, you would have nearly a perfect mirror image over the past six months.
In August of 2015, WTI dipped just under $38 before bouncing back to near $51 within two months. This summer, WTI made the inverse move, hitting a 2016 high of $51 before dipping back to around $39 within 2 months.
If this reversal pattern holds, the recent dip to $39/bbl was simply part of the long-term recovery process. As the reverse head and shoulders pattern continues to develop, looking back farther into the past is the best indication of what traders should expect in the near future.
Prior to hitting $38/bbl last year, WTI took a pretty steep two-month dive from around the $62 level. If the inverse pattern holds, oil traders should expect WTI to hit $60/bbl again by the end of October.
If the pattern breaks down at any point within the next couple of months, a key support level to watch will be the $39/bbl August low. A breakdown below that level would be particularly damaging.
Traders betting the pattern will hold should consider the United States Oil Fund LP (ETF) (NYSE: USO). Longer-term investors should instead look to diversified equity ETFs like the Energy Select Sector SPDR (ETF) (NYSE: XLE) or the VanEck Vectors Oil Services ETF (NYSE: OIH).
Disclosure: the author holds no position in the stocks mentioned.
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