September Crude's 2B Test of Top

07/08/03 12:32:54 PM

by David Penn

While the world waits anxiously for thousands of barrels of Iraqi oil to enter the market, this technical indicator suggests that cheaper oil may be coming--one way or the other.

Security: CLU3
Position: N/A

In a recent article for The Weekly Standard, the neo-conservative magazine that has made a major comeback in the past few years based on its expansive view of America's place in the world, Irwin Stelzer echoed many of the concerns about the progress of rebuilding Iraq's oil production system in the wake of the war to oust Saddam Hussein. Stelzer's concerns include problems with power supplies, the greed of OPEC, oil pipeline sabotage and, most intractable, the goal of changing the model by which resource-rich countries has failed to pursue "both economic modernization and economic growth." Stelzer notes that "with no need to tax its citizens, an oil-rich country has no need to offer good governance. The result is no taxation with no representation, either."

All this plus an oil worker strike in Nigeria to boot? Surely, a casual observer might remark, this means that higher crude oil prices-- at least in the meanwhile-- are more likely than lower crude oil prices. This casual observer might reasonably deduce from that opinion that continued higher crude oil prices might act as an anchor to stock prices, keeping them from fully resuming their bull market advance that began back in mid-March.

These observations and deductions may turn out to be quite valid. But, for now, the main ingredient in this scenario-- crude oil-- is not cooperating.

A break beneath this two and a half month uptrend line could add to the bearish signals given by a successful 2B test of top in July.

Graphic provided by: TradeStation.

Crude oil (basis September) has been in a bull market since late April, when it traded around $25 in the wake of a collapse from pre-Iraq war highs north of 31 in early March. From late April to late June, crude oil futures retraced a sizable percentage of the March decline, with September futures making a peak of 30.55 early in July. However it is the price action since that early July high that should have the attention of traders-- as well as anyone else who fears that the plan to bring Iraqi oil to market is hopelessly off-track, or that striking Nigerian oilworkers will bring production to a standstill, or that Venezuela's Hugo Chavez will provoke a conflict that further destabilizes oil production in that South American nation.

The twin secondary peaks in September crude (secondary in relation to the early March peak above 31) in June and July represent a 2B test of top for crude that could be anticipating significantly lower prices for crude oil going forward. The 2B test of top occurs when prices make a high, pull back, then make an even higher high. If there is follow-through to the upside after the higher high, then the test of top is unsuccessful and prices are likely to continue moving higher. If, however, there is no follow-through to the upside after the higher high and instead prices reverse course and begin moving lower, then there is an increased chance that the higher high top will hold and that prices will continue to move lower.

In the case of September crude, we appear to be presented with the latter instance. After making a high of 30.20 on June 11th, crude oil pulled back a sizable 8% to a low of 27.65 a little over a week later. Crude oil rallied from this low to make a higher high of 30.55 on July 3rd. This set up the opportunity for the test. Instead of rallying still higher, crude oil futures dropped in subsequent days with highs around 29.80. Based on this failure to follow-through to the upside after the higher high on July 3rd, it appears that September crude is likely headed for a significant correction.

Possible support areas that are worth noting include, foremost, the June 19th inter-trough low at 27.65 mentioned above. It should be added that this support level is built not only on the back of the inter-trough low, but also on the consolidation range highs of mid-May, which found support at the 27.75 area.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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September Crude's 2B Test of Top

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