Oil is getting stronger and stronger (and speaking of it, they just recovered oil for the third time at InterOIL), let’s see whether that spills over into the sector..
Commentary: Oil continued its surge, hitting a six-month high near $63 for the first time since November, 2008. It seems like oil is starting to ignore the ongoing slowdown in consumption and weak economic outlook. Much like other commodities, the price of oil also benefits from a falling dollar. Not so coincidentally, the dollar has been dropping since March, which is just about when it bottomed out. While it could be argued whether a rally in oil is sustainable with a bleak economic picture, as traders we must follow price action and trade accordingly. (For more on this debate, see Oil As An Asset: Hotelling’s Theory On Price.)
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With the price of oil rising, oil service stocks have been benefiting, and the result has been an increase in share price for several of these companies. The Pro Shares Ultra Oil and Gas Index ETF (NYSE:DIG) measures the performance of the energy sector and components include oil drilling equipment and services, coal, oil companies, pipelines, and gas producers and service companies. It had been trading in a channel for several months until attempting a breakout in late April. It has been consolidating since then, while holding above the breakout area. It looks like it has successfully tested the breakout area, and is forming a bull flag type consolidation. A break above the trendline could easily lead to a test of the 200-day moving average, and possibly more.
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Schlumberger Limited (NYSE:SLB) is an oil service company that has developed a similar pattern to DIG. It traded in a large base that spanned several months, after a brutal decline in the second half of 2008. It broke above this base in late April, and rallied to its declining 200-day moving average. While it failed on its first attempt, it has been consolidating under the average and is also forming a bull flag pattern. These patterns are typically continuation patterns, so a move above the flag could yield a great trade.
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Southwestern Energy Company (NYSE:SWN) is another stock in the energy sector that is displaying a breakout above a several month long base. SWN set a higher low in April, when the pullback ended short of the established trading range. It then proceeded to clear the base and gain over 20% from the breakout area. It has been trading in a bull flag for the past few weeks, and a break of the trendline could result in a sharp gain for SWN.
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Western Refining, Inc. (NYSE:WNR) is an oil refiner that is exhibiting a similar pattern to the others, although the trading levels are not as clear cut. WNR just recently cleared a much larger base (not shown) that began last May. The smaller base shown in the chart is an ascending triangle that was cleared on high volume. The breakout is in the process of testing support, and if it holds this area, then the estimated target based on the just the triangle pattern is near $18. This could offer a decent “risk versus reward” trading setup for aggressive traders. For more, see A Guide To Investing In Oil Markets.)
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The Bottom Line
With oil at fresh multi-month highs, it’s possible that momentum can carry the price farther than most think. Each of the oil stocks above have cleared a base spanning several months, and are in the process of consolidating their breakouts. If either the dollar continues to weaken, or the economy shows any signs of strengthening, these stocks could benefit with a continuation of their breakouts. While these stocks are still in a longer-term bear market, there is plenty of room for a corrective move higher in the short to intermediate term. Rallies in bear markets can often produce sharp gains quickly, so as traders we must be open minded to all possibilities. Do you think these stocks can move higher from these levels, or is a bull trap being set? Let us know what you think by participating in the Investopedia Simulator.
Charts courtesy of www.stockcharts.com
By Joey Fundora
At the time of writing, Joey Fundora did not own shares in any of the companies mentioned in this article.