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Why We Must Keep a Close Eye on Oil

While most sectors were tanking at the start of 2022, crude oil went on a bullish tear.

A rapid rise in oil prices saw the Energy Select Sector SPDR Fund (XLE) gain 70% in just six months. This added more pressure to runaway inflation.

However, as buying momentum evaporated in early June, XLE strongly reversed. By mid-July, XLE had lost almost one-third of its value.

On September 6 (red arrow on the chart below), XLE’s selling pressure had abated, allowing it to form a base.

After that, XLE began retracing after a two-month bull run – which had seen it top out at a lower high.

The price of oil has continued to swing. So today, we’ll see what’s in store for this volatile commodity.

Strong Reversals

XLE’s huge bull run kicked off in early January, with the 10-day moving average (MA – red line) breaking above the 50-day MA (blue line)…

Take a look at the chart…

Energy Select Sector SPDR Fund (XLE)

Source: eSignal

But after peaking at ‘A,’ XLE tumbled as the Relative Strength Index (RSI) reversed strongly from overbought territory (upper grey dashed line).

As the RSI crashed straight down through support (green line) into the lower half of its range, XLE continued its fall. And the 10-day MA bearishly crossed back below the 50-day MA at almost right angles.

Only when the RSI fell into oversold territory (lower grey dashed line) – and gradually started tracking higher – did XLE find a base.

Eventually, the divergence (red lines) between the RSI (higher lows) and XLE (lower lows) swung momentum behind the stock price and caused XLE to grind higher.

Once the RSI gained traction in the upper half of its band, XLE continued its rally. And the 10-day MA broke back above the 50-day MA, adding positive sentiment.

But then, the RSI reached overbought territory again and reversed sharply. This saw XLE make a lower high at ‘B.’

Take another look…

Energy Select Sector SPDR Fund (XLE)

Source: eSignal

From there, the RSI tested and held support throughout the first half of September (red circle).

But after dwindling momentum saw the RSI and XLE track lower again, the two MAs crossed back the other way.

Now, the RSI formed a ‘V’ from oversold territory and recently broke back into the upper half of its range. Meaning, things are looking promising again.

So what can we expect from here?

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A Prolonged Rally?

What happens with the RSI around this level is key.

If the RSI gains traction in the upper half of its band, then this up move will continue to gain momentum. The longer the RSI can remain in this upper range, the more prolonged this rally could be.

But I’ll also be closely watching the RSI if it tracks into overbought territory again.

If the RSI forms an inverse ‘V’ from this territory – and reverses at a lower price level than ‘B’ – then that’ll put a cap on any move higher.

We would likely see XLE roll over and continue to trend lower.

However, a reversal from the RSI – back to support or lower – could provide nimble traders with the chance for a short trade.

Regards,

Larry Benedict
Editor, Trading With Larry Benedict

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