Mapping Crude Oil Prices: No Market Can Be Forecasted Perfectly, and to Get a Handle on the Volatile Crude Oil Market You Need All the Tools You Can Get. That Means Using Both Technical and Fundamental Analysis to Predict Prices

By Duke, Phil | Futures (Cedar Falls, IA), December 2006 | Go to article overview

Mapping Crude Oil Prices: No Market Can Be Forecasted Perfectly, and to Get a Handle on the Volatile Crude Oil Market You Need All the Tools You Can Get. That Means Using Both Technical and Fundamental Analysis to Predict Prices


Duke, Phil, Futures (Cedar Falls, IA)


This much is obvious: to profitably trade markets, it is necessary to predict the movement of prices. However, price action can be predicted only in terms of probability; nothing is certain. Many traders have been broken by not realizing that even though an event is highly probable, it still may not occur, and that even though an event is highly improbable, it still may occur.

This is true in any market, and heading into 2007, it is true for the extremely volatile crude oil market.

Throughout time probable events will become actualities more often than not. This brings us back to the problem of evaluating price movement probability. The two methods commonly employed to do this are technical and fundamental analysis, and the proper application of both is necessary for an analysis of the probable, but by no means certain, direction of crude oil prices in 2007.

BEHIND THE PRICES

Technical analysis holds that prices and price actions depend on market sentiments, which are often stated to be fear and greed. This approach assumes that the most reliable indicators of future prices via market sentiments are price action, volume, open interest and indicators based on these measures.

Another area of technical analysis draws on certain whole Fibonacci values obtained by adding successive numbers such as 1, 2, 3, 5, 8, 13, 21, 34, 55. Other analysis methods that are generally lumped in the technical analysis area assume prices tend to turn near symbolic whole numbers. The $30 level in the past was seen as a sure sign of overbought conditions. As the market rallied, the benchmark rose to $40, $50, $60 and so on until no one could get anyone's attention unless they called for $100 crude oil.

Implied in these techniques are the tenets that price actions indicate future prices by providing information on underlying/changing market sentiments and that financial history tends to repeat itself. In other words, the way sentiments affect price actions remains basically the same through time because human emotions and actions based on them remain the same.

Certainly, technical analysis is not perfect. It assumes everything affecting sentiment is in the market price. It makes no provision for new, unexpected news that may enter the market suddenly and change sentiment. Of course, news is constantly entering the market, some of which may markedly change sentiment. Any and all technical analysis may fail at any time due to unexpected news.

While few markets are as sensitive to news shocks as crude oil, technical analysis still provides a great deal of information about the current condition, and possible future direction, of crude oil prices.

Crude oil prices have been in a multi-year long-term uptrend. Prices recently closed below the uptrend lower channel line; this is a traditional technical signal that tends to mark the end of any existing, prevailing trend. Confirming this break, the subsequent pull up did not reach the prior high. Prices then fell and have continued to decline into the fourth quarter of 2006.

It is impossible to predict accurately how low prices will fall before bottoming. It is a fool's game to try to fore-cast bottoms before they happen. Rather, the technical analyst should look for signs of a bottom as it occurs.

Typical bottoming signs include:

1. Price pull downs and pull ups do not make new lows.

2. A bottoming chart pattern is formed, such as a double or triple bottom.

3. Directional indicators such as On-Balance Volume, the Relative Strength Index and moving average convergence-divergence turn upward.

4. Trend reversal candlestick patterns are formed, such as dojis and hammers.

5. The downtrend upper trendline is penetrated decisively.

6. The 50-day moving average crosses above and rises above the 200-day moving average.

When you begin to see these signs, it is time to consider covering shorts and looking to possibly establish long positions. …

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