In this second of two articles, we explain the most common technical indicators used to describe the oil markets.
We've recently looked at the tools used to gauge petroleum fundamentals ("Oil Market Indicators Explained: Part 1"). Now it's time to turn our attention to the technical side: chart reading.
Technical analysis—examining charts to discern patterns predictive of future price trajectories—is gospel to some investors, anathema to others. We're not going to wade into that dispute here. Whether you're a fan of technical analysis or feel it's bunk, a price chart can help you quickly surmise a commodity's history.
Fundamental and technical analysis aren't mutually exclusive. Many investors use both types of indicators to interpret the market and pinpoint potential entry and exit points. It's for these investors that our Wednesday oil reviews are most useful.
So, what can a price chart tell you? Let's look at the markers most often employed when analyzing crude oil.
The chart embedded in our weekly oil column tracks the settlement prices of the nearby West Texas Intermediate contract traded on the New York Mercantile Exchange. Unlike bar or candlestick charts, just one price is assigned for each trading day. The inherent assumption is that the settlement value is the most important price of the day.
You can argue the merits of that notion if you like, but one thing is certain: Using the settlement price simplifies the chart, making it look less cluttered.
Nearby WTI Crude Oil
Support And Resistance
Often our price chart will include yellow lines denoting areas of support and resistance.
Support levels are typically drawn below the current market price and represent areas where demand is strong enough to overcome downward price pressure. Buyers are more aggressive at support levels, while sellers become more timid.
Support levels can be discerned in a number of ways. Most commonly, support lines can be drawn from the market's previous reaction lows—places from which prices have bounced back from a downturn to trade higher. In our chart above, an upward-sloping support line—in this case, the baseline for oil's current uptrend channel—was established in midyear 2010.
Moving averages, too, can represent support levels. Typically, longer-term averages are more reliable as support. We'll examine moving averages more in a minute
Retracement levels can also be considered areas of potential support, but we'll cover those separately.
Consider resistance as the polar opposite of support—a price level where sellers are emboldened enough to keep prices from rising further. Supply emerges as prices advance toward resistance, eventually swamping demand.
Resistance levels are most often painted above the market's current price, typically extending from the market's previous reaction highs. The upper boundary of crude oil's up-channel, for example, was drawn from a series of 2009-10 reaction highs.
Support and resistance levels aren't immutable; in fact, they're often transmutable. Support, once broken to the downside, can turn into resistance, and vice versa.
A break in support signals that supply has managed to overwhelm demand. Should prices subsequently return to the level of previous support, an outpouring of supply is likely to tamp down further price advances, and presto-change-o, that level becomes new resistance.
The flip side is a breaking of resistance when aggressive buying overpowers sellers. Here, demand strips supply. A fallback to that level will drive demand, supporting the price.