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The Fear Factor

Oil markets are nervous animals nowadays. Given the tensions between Iran and the U.K. since late March over Tehran's seizure of 15 British sailors, the prospect of diplomatic efforts failing to solve the stand-off haunted the market. That's raised fears of a military confrontation in the Persian Gulf. After Iran pardoned and freed the 15 sailors, the market was so relieved that oil prices dropped by over $2.

Energy traders believe a 'fear premium' is building once again in the price of crude oil to account for a greater perceived risk to energy supplies. Diplomatic analysts and political scientists don't make the best oil traders ... and vice versa. But armchair political analysts are what oil traders have become of late, trying to map out the latest twists and turns of a diplomatic chess game, weighing up the possibility of one thing -- do the developments take us any closer or any further away from supply disruption.

Over the course of the crew's seizure, the markets played out a number of worse case scenarios, most dramatically, a naval blockade of the Straits of Hormuz – where a quarter of the world's oil flows through – or a repeat of the 'Tanker Wars' of the 1980s when shipping was targeted.

Runaway Rumor Mill

Financial markets recently got a glimpse of just how sensitive oil traders were to rumors of military action involving Iran. Towards the end of March the rumor mill hit top-gear.

On March 28th, prices jumped $5 in after-hours trade in a matter of minutes to about $68 a barrel – the highest in nearly six months – after unsubstantiated rumors that Iran had fired on a U.S. naval vessel.

The ‘Fat Finger’

Traders said the move was perhaps exaggerated because the spike occurred in light after-market, volumes. Another theory circulated that the spike may have been caused by an erroneous trade, where a dealer, executing a buy order, mistakenly hit an extra zero key (or two) on his keyboard, a gaffe known in the industry as a 'fat finger'.

The geo-political tensions influencing crude oil prices have since eased. The fear factor has crept away, but for how long? The market will never fully tune out the geo-political noise as long as the potential exists for flashpoints in the Middle East not to mention ethnic and civil unrest in OPEC producers such as Venezuela and Nigeria.

How then can does one trade in a market that is at the mercy of geo-politics? Technical trading offers a strategy. Supply and demand fundamentals together with the geo-politics are stripped away. Instead, traders study charts detailing trading history over a given period. Such technical analysis helps them understand the probability of future price moves.

Getting Technical

Given their recent volatility as I just outlined, oil prices are a popular subject for technicians to chart. CNBC regular Daryl Guppy is a technical analyst and chartist with Guppytraders.com.

In a recent commentary, Guppy correctly predicted that a move above a key trend line on a weekly chart would take the price of NYMEX light crude oil above $63. Prices have typically paused and consolidated in the $62-$63 level before changing direction. "A breakout can carry the price to $68 before any significant chart resistance is encountered," he said.

Prices have been in an uptrend since March 20 (indicated by trend line B in the chart), rising by $8.60, or 15% to, close at $65.73 a barrel on March 30. Where's the next level? “The price rise towards $68.00 has several good support features that confirm the bullish nature of the current trend breakout. A breakout above $68.00 has a price target of around $78.00," Guppy notes.

Technical trading patterns are not for everyone. Oil traders tend to be divided into camps of fundamentalists and technicians though some traders co-mingle the two schools of thought.

But $78 is also the target set by oil billionaire and Chief Executive of BP Capital Boone Pickens. In an interview on CNBC’s “On the Money” Pickens told our Melissa Francis, "I think the world is short of energy. There will be dips, but the trend is up." Pickens expects oil will "test the highs" around $78 before the end of the year and if there is a serious disruption of supply from Iran, Pickens says, "the sky's the limit."

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