It doesn’t take much to guess that oil prices will rise. But if you look ahead in time from the current point in time on a chart, you can seem something bubbling up on the right edge of the chart. The price pattern of oil suggests that it could rise further. The ides of March saw a flag pattern nearly complete. A breakout from this pattern will implies that crude oil has completed its consolidation and is set to rise for the next six weeks or so. When this kind of pattern is predictive, it usually has higher volume at the peak of its rise, and then declining volume through its consolidation. That’s what appears to be happening now (see figure below).
Should the price of iPath S&P GSCI Crude Oil Total Return (OIL), the ETF that roughly tracks changes in crude oil prices, close above the downward sloping lines of the flag pattern, a ten percent increase is likely to follow. Here is how it works.
Flag patterns have three distinct parts. The first is a rapid rise in price, the second is a range-bound pattern of consolidating price structure, and the third is a rapid rise similar to the first part.
The flag pattern in OIL shows two of the three parts currently and is poised to begin its third part. As you can see in the figure above, the price rose rapidly from approximately twenty four and a half dollars per share at the beginning of February. This rise (often called the flag pole) culminated in a peak price of around twenty eight dollars per share just as March began. Since that point in time the price of OIL has shown a downward-drifting pattern.
The second part of the pattern, the flag itself, is so called because it seems similar in shape to a flag hanging slightly from the pole. Notice for this part that the volume pattern matches expectations nicely. Investors were enthusiastic while the price was running up the flag pole. Volume rose during this phase. The top of the flag pole also has a tall volume spike. Since that point it time, the volume has generally trended lower. That’s what typically happens in this pattern. The dwindling volume is thought to contribute to the downward drift of the price action, because fewer market participants are involved and neither buyers nor sellers can generate sufficient activity to move the price beyond a temporary range of equilibrium.
Not all prices break out, but those that do follow the third part of the pattern. It usually begins with a day of price action that has strong volume, and closes confidently closer to its high than its low. When such a breakout occurs, if the volume of that day is significantly above average then it predicts that a strong move will follow.
The price often retests the down-sloping trend line, but in those more rare instances when it does not retest, the rise is faster and longer lasting. Based on this action, it could portend a rise in crude oil prices above $125 per barrel by the end of May.
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