Charting Asia

Oil's rise: Trend change or short-term rally?

Pump jacks in an oil field over the Monterey Shale formation near Lost Hills, Calif.
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Iraq's sudden fall into the hands of extremists has the market talking about extremes in oil prices. Extreme may be too strong a word, but there is slightly more bullish pressure than there was around at the time of the last oil crisis.

Developments in Ukraine and the annexation of Crimea had the potential to effect oil and energy supplies in Europe but failed to do so. While the Ukraine crisis accelerated the rally in NYMEX oil that started in the week of January 18, 2014, it was a short-term rally in the environment of a slow longer-term uptrend. The current Iraq-driven rally has a similar nature but is starting from a higher base.

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Trend line A on the weekly NYMEX oil chart shows an uptrend starting June 2012. This trend line connects the lows in November 2012 and April 2013. This is the underlying secular trend, located within the context of well-defined trading bands.

The weekly NYMEX oil chart shows four levels of support and resistance that define the trading bands: $78, $88, $98 and $110.

Starting in July 2012 oil has traded in a sideways band between $88 and $98. The breakout above this trading band in July 2013 was not the start of a new uptrend but rather a temporary rally towards resistance near $110. This type of behavior is likely to be repeated in the current crisis environment.

Starting in March 2014 oil developed a temporary resistance level near $104.50. This created a small up-sloping triangle, which can be used to project the upside target for the current rally. The upside projection target is $110 – the long-term historical resistance level since 2011.

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The current rally breakout above $98 has the same pattern of behavior as the rally breakout in July 2013. This past behavior suggests there is a high probability that resistance will again be strong near $110. There is a high probability the current rally will be limited to $110 with the potential to spike to previous historical highs near $114. This has the characteristics of rally behavior rather than a long-term trend change.

Traders will trade from the long side as the rally moves upwards. When the rally moves near $110 resistance they will tighten stops to protect profits. There is a high probability the price will consolidate near $110 and perhaps establish a trading band between $110 and $114. The downside target for the retreat from resistance is near $98.

Daryl Guppy is a trader and author of Trend Trading, The 36 Strategies of the Chinese for Financial Traders – He is a regular guest on CNBCAsia Squawk Box. He is a speaker at trading conferences in China, Asia, Australia and Europe.