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Momentum Turns Bearish – What’s Next?

October 19, 2022| Forex Market

Crude Oil Outlook:

  • The October crude oil price rally failed in recent days, but has found support at a multi-month downtrend.
  • Bearish momentum has reasserted itself on both the daily and weekly timeframes.
  • According to the IG Client Sentiment Index, crude oil prices have a bearish bias in the near-term.

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What Goes Up Comes Down

Crude oil prices had a strong start to October and 4Q’22, but a return of global recession concerns and an expected announcement of another Strategic Petroleum Reserve (SPR) release by the Biden administration has weighed on price action in recent days. While many if not all global recession concerns are largely priced in, the news at the start of the week that China would be delaying the release of their 3Q’22 GDP report led investors to believe that the world’s second largest economy is facing a more difficult situation than previously envisioned. And so, the choppy price action has continued for crude oil prices, giving up most of their October gains, leaving the market in a technically ambiguous area.

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Oil Volatility, Oil Price Correlation Turns Positive

Crude oil prices have a relationship with volatility like most other asset classes, especially those that have real economic uses – other energy assets, soft and hard metals, for example. Similar to how bonds and stocks don’t like increased volatility – signaling greater uncertainty around cash flows, dividends, coupon payments, etc. – crude oil tends to suffer during periods of higher volatility. Crude oil volatility falling has curiously coincided with a sharper decline in oil prices.

OVX (Oil Volatility) Technical Analysis: Daily Price Chart (October 2021 to October 2022) (Chart 1)

Oil volatility (as measured by the Cboe’s gold volatility ETF, OVX, which tracks the 1-month implied volatility of oil as derived from the USO option chain) was trading at 52.06 at the time this report was written. The 5-day correlation between OVX and crude oil prices is +0.66 while the 20-day correlation is -0.22. One week ago, on October 12, the 5-day correlation was +0.37 and the 20-day correlation was -0.16.

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Crude Oil Price Technical Analysis: Daily Chart (October 2021 to October 2022) (Chart 2)

Over the past week, crude oil prices were rejected at the dynamic support/resistance zone between 90 and 93 in place since February. The move lower has seen crude oil prices return to the downtrend from the June and August swing highs. In turn, momentum has turned bearish. Crude oil prices are trading below their daily 5-, 8-, 13-, and 21-EMA envelope, which is in bearish sequential order. Daily MACD is dropping below its signal line, while daily Slow Stochastics are falling below their median line. More choppy, sideways trading could be ahead; no significant strength nor weakness is expected to transpire.

Crude Oil Price Technical Analysis: Weekly Chart (March 2008 to October 2022) (Chart 3)

Bearish momentum is starting to return on the weekly timeframe. Crude oil prices are back below their weekly 4-, 13-, and 26-EMAs, and the EMA envelope is in bearish sequential order. Weekly MACD is turning lower below its signal line, while weekly Slow Stochastics are still below their median line. As noted last week, “a weekly close above the weekly 26-EMA…would help reinforce the bullish technical reversal narrative,” but that hasn’t transpired, keeping bears firmly in control.

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Oil – US Crude: Retail trader data shows 71.13% of traders are net-long with the ratio of traders long to short at 2.46 to 1. The number of traders net-long is 2.52% higher than yesterday and 20.44% higher from last week, while the number of traders net-short is 5.36% lower than yesterday and 34.60% lower from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests Oil – US Crude prices may continue to fall.

Traders are further net-long than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger Oil – US Crude-bearish contrarian trading bias.

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— Written by Christopher Vecchio, CFA, Senior Strategist

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