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Crude Oil: Completes Small Head and Shoulders Bottoming Pattern

After a decline from near 100 in mid-2014, to a low of 44.03 in March, have crude oil futures (CL) finally bottomed?

The May crude oil contract completed a--not very pretty--small inverse head and shoulders pattern on April 7, indicating the potential for higher prices to come. A more than 2% rally in early trading on April 7 pushed the price of crude above the neckline of the pattern. Given the height of the inverse head and shoulders, added to the breakout point, the target is approximately $63.

Figure 1. May Light Sweet Crude (CL) - Daily Chart

There are few cautionary notes to consider though. The inverse H&S pattern is relatively small in the context of the larger downtrend, which is still in effect. Under such circumstances, the inverse H&S often appears as a continuation pattern, not a reversal pattern. A fall back below $47 makes that a possibility.

Also, while the price has rallied above the neckline of the inverse H&S, it is still in a resistance zone. $56.08 is the high point in this pattern, and represents an area the price must move past in order for the short-term uptrend to continue. The price could also reach that area, and then proceed to form another right shoulder. While some traders will be eyeing this area for a breakout higher, a lot of traders will be looking at it is a shorting or selling opportunity.

With valid arguments on both the bullish and bearish side, how to proceed? If you believe the odds favor the bulls, buy, placing a stop below $47 and a target near $63. If you favor the bears, wait for upside momentum to slow, and when it turns back to the downside, sell, assuming the price is still within a couple dollars of the $56 or below (as a strong breakout above $56 doesn't bode well for the bears). Stop loss goes above the recent high and an initial target goes near the $44.50 (just above low).

The alternative is to wait. Let the price breakout in either direction, then wait for a correction to get in. With the current market structure, this may be the best option at the moment.

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