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Technical Analysis

Where does oil price go?
Follow the 200-day moving average

Where does oil price go?

By Jason Chow
Globeinvestor Magazine Online, Aug. 8, 2008

How quickly the markets can scare away the bulls. Just one month ago, the stampede that set oil prices skyward seemed unstoppable. Oil lovers said demand for the commodity coupled with increasing speculation would send the commodity price to $200 (U.S.) by year end. And at that moment with record-breaking prices, it seemed plausible to most and destiny to the most ardent fans.

But since then, the rally has hit a wall and the gusher has stopped. Prices topped off at $147.27 (U.S.) on July 11 and have dropped more than 21 per cent to near $116 on Friday.

So, what about that $200 forecast? Is the current downward move a short-term hiccup of the massive bull run that ran most of this year? Or is it proof that the $200 level was just a lofty idea for the greedy oil traders?

Already, the consensus is backing far away from those earlier forecasts. The latest call for $200 oil came on Friday when Chatham House, a British think tank, published a report saying that oil would hit those prices because of increasingly difficult access to supplies. But unlike the bulls of July, the think tank said this price would be reached in five to 10 years.

And according to the technical analysts, those who look to price action and charts to predict market movements, oil prices still have room to drop before they go back up. And they think it's highly unlikely we'll see the stratospheric projection any time soon.

"When you have something going up as steep as possible and hitting new highs, people don't think it's the end of it," said Jeff Parent, a technical analyst and portfolio manager with Quadrexx Asset Management in Toronto, who think the $200 mark is out of reach for 2008. "They thought it could keep going up but at some point, you run out of buyers."

Mr. Parent says investors and traders have been selling en masse and cashing out of what was a spectacular rally. And while he sees more downward pressure for the commodity, he doesn't see it dropping to double-digits for very long, if it even does. And his forecast has little to do with complex indicators or charts. For him, there are two reasons and the first is purely psychological: He thinks investors won't let oil go below the $100 line.

"There's a solid support level there," he said. "Prices like $100 and $150 have a strong psychological hold. It's like the odometer on your car. You don't pay attention to the mileage when it turns from 98,000 to 99,000 but when it goes over 100,000, then all of a sudden you think your car is getting old."

He added, "You get more activity at even dollar amounts. There's no fundamental reason. People are just trying to eyeball and round off."

To Mr. Parent, the other real indicator that will signal another upward trend will be how the current price relates to the 200-day moving average, he says. Right now, the commodity price is above the average, which is currently around the $109 mark, but once the price moves close to the average or below it - what technical analysts call a "crossover" moment - then, to many market observers, it signals a trend reversal and the start of a new rally.

"Forget the fundamentals and all those stories that the downturn in the economy is hurting demand. We've had a weak economy for the most of the year and prices kept rising. What it's really about is moving average. It's that easy."

Chris Vermeulen, trader and editor of thegoldandoilguy.com newsletter, says the 200-day moving average is not his own buy-or-sell indicator but he says it's a way to gauge the sentiment.

"It's not part of my trading model but I do look at it. It's important because so many people look at it, including novice investors and institutional ones. Oil is still overbought right now. It's still above the 200-day line. But it's starting to settle into the moving average. It's a good spot. And if we get support there - if prices don't break down and just kind of move horizontally at that level - then we could start a whole new wave."

Mr. Vermeulen insists he doesn't forecast prices, but he did advise to be wary whenever the crowd starts anticipating outrageous bull runs, like the $200 call from earlier in the year.

"Everything was so extremely bullish in the past year. When everybody starts making calls like that, you know it's near the end. You could see it happen. By July, the moves were getting so jumpy, with prices moving several dollars both ways every day. That was a big sign to doubt that it's going to go any higher."

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