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Friday, September 05, 2008

$80 Oil? Inflation Adjusted Gasoline and Oil Charts Suggest Odds are Good

The graphs of inflation-adjusted gasoline prices and the price of oil (more oil charts) below are good news for the global economy. Prices for both gasoline and oil could continue to fall as the global economy slows. The best news is technical analysis indicates the prices of oil could fall a lot more, perhaps into the $70s if the "Head-and-Shoulders Top" reversal pattern now in play resolves to its price target.

Chart courtesy of www.chartoftheday.com

The chart below of oil prices vs the S&P500 shows the price of oil has completed a "Head-and-shoulders reversal," very important reversal pattern for those who practice technical analysis.

If you look closely at the above chart of oil prices, you can see two head-and-shoulder (H&S) patterns have formed what I've coined a "compound head-and-shoulders pattern." A compound H&S patterns in one H&S pattern inside another. I show the neckline for H&S#1 at $121. You can see this neckline breakdown was tested from below while forming the right shoulder of a second H&S pattern with a neckline at $111.

A reason to be bearish on the price of oil (expect declines to continue) is three key support levels have been broken. These are:
  1. H&S #1 at $121
  2. H&S #2 at $111
  3. The 18 month uptrend support (dashed blue) line also at about $111.
The H&S patterns project oil will drop into the $70s and $80s while the point-and-figure chart projects $96, a good 10% lower than were oil was yesterday at the close.

More on "Head-and-Shoulders" chart patterns


The Bible for technical analysis, Technical Analysis of Stock Trends, by Robert Edwards and John Magee, covers the "Head-and-Shoulders" chart pattern in Chapter six (starting on pg 59)

Note, "Edwards and Magee" states the neckline has to be broken for the reversal pattern to be in play with the target price. They say about 20% of patterns break the neckline with the proper volume attributes, flounder about for a bit, then return to higher levels to negate the reversal pattern.

As with all Technical Analysis, it would be a science rather than an art if the patterns were 100% reliable.

Conclusion:

Today the economy is suffering from inflation from high oil prices plus an economic slowdown in large part due to higher energy costs sucking spending power from consumers and business owners. This has thrown the market averages into bear markets.
If oil prices continue lower to to $70s, $80s or $90s, then consumers and business owners will have more to spend. If the credit markets can work out their issues, then consumers and business owners will have access to low cost money again too. More money to spend should help the markets recover in the long term. Thus, I've been using these major sell-offs as time to add to equities in my "newsletter explore portfolio" and my personal portfolio too. While writing this article, I added to one of the stocks covered in my newsletter. I bought just minutes after I got word from a program that monitors the SEC that two insider buys were made on a stock I wanted more of.

Kirk Lindstrom's Investment Letter Performance

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