The West Texas Intermediate (WTI) crude oil futures contract zoomed higher in April after a historic decline into negative numbers, driven by idiosyncrasies between the futures contract and physical delivery requirements. It topped out in the low $40s in August and fell to a six-week low this week, with positive seasonality dropping off the calendar while traders speculate on the economic impact of a potential second wave. This decline could pick up steam in coming weeks, potentially dropping the instrument into the mid-$20s.

Key Takeaways

  • Crude oil may have topped out in the low $40s and could now sell off into the mid-$20s.
  • The April decline into negative numbers was an aberration that's unlikely to be repeated.
  • The futures contract may have entered a new long-term uptrend at the April low.

The contract entered a heavy zone of resistance in June when the two-month recovery wave reached the March 2020 breakdown through the 2018 low in the lower $40s. Momentum faded immediately, but selling interest failed to appear, allowing price to drift higher and add a few points into August. The change in the calendar has reawakened bears for the first time in five months, generating a downtick that needs to hold the $40 level to avoid a larger-scale decline.

Crude oil prices are highly vulnerable to economic forces, rising in strong conditions and selling off during recessions and downturns. Anecdotal data suggests that the economic recovery since the first quarter is losing steam, with continued high unemployment and the lack of fresh stimulus lowering demand. Conditions this fall and winter pose a huge wild card in this equation because no one can accurately forecast the pace of the pandemic or when an effective vaccine will become widely available.

Momentum is the speed or velocity of price changes in a stock, security, or tradable instrument. Momentum shows the rate of change in price movement over a period of time to help investors determine the strength of a trend. Stocks that tend to move with the strength of momentum are called momentum stocks.

Continuous Monthly WTI Crude Oil Chart (1983 – 2020)

Monthly chart showing the price performance of crude oil
Investing.com 

The continuous futures contract shows excellent technical symmetry, establishing a deep trading floor near $10.00, created by the 1986 and 1999 lows. The contract topped out in a climactic 2008 blow-off, tagging the first point in a massive descending triangle that carved a near-perfect trendline of lower highs into October 2018, when it reversed at a final point in the mid-$70s. Meanwhile, 2008 and 2015 declines established horizontal support in the mid-$30s, violated on heavy volume in the first quarter of 2020.

The decline broke the 1986 low in April, dumping the contract into negative numbers while generating massive volume that expanded into energy stocks. This unusual activity may have completed a trend climax that has the potential to establish a new long-term uptrend. The subsequent uptick entered a zone of resistance at the triangle breakdown in May, just a few points under the first quarter breakdown through the 2016, 2017, and 2018 lows.

A descending triangle is a bearish chart pattern used in technical analysis that is created by drawing one trendline that connects a series of lower highs and a second horizontal trendline that connects a series of lows. Oftentimes, traders watch for a move below the lower support trendline because it suggests that the downward momentum is building and a breakdown is imminent. 

Continuous Daily WTI Crude Oil Chart (2017 – 2020)

Daily chart showing the price performance of crude oil
Investing.com

A Fibonacci grid stretched across the 2020 descent into negative number places the top of the five-month bounce right at the .786 retracement level, which marks a high-odds turning point. In addition, the contract has filled the March breakdown gap, with the fill level perfectly aligned at the harmonic retracement. The narrowly aligned 200-day exponential moving average (EMA) and broken lows add predictive power to this major inflection point, setting up ideal conditions for a reversal and renewed selling pressure.

How low could crude oil go in coming months? First, let's rule out another trip into negative numbers because that aberration is unlikely to be repeated in our lifetimes. A more conservative view seems to fit the current scenario better than dire outcomes, suggesting downside into the .382 Fibonacci retracement level almost perfectly placed at $25. The good news for bulls: a strong bounce in that zone could print a higher low within a long-term uptrend that blasts through the 2020 high in coming years.

The Bottom Line

Crude oil may have topped out and entered a pullback that could reach the mid-$20s in the fourth quarter or in early 2021.

Disclosure: The author held no positions in the aforementioned securities at the time of publication.