2 low-risk ways to play the oil rally

These stocks show favorable chart patterns and are close to staging upside breakouts.

By MoneyShow.com Nov 11, 2011 1:25PM

Image: Oil drums (© Kevin Phillips/Digital Vision/age fotostock)By Tom Aspray, MoneyShow.com


Stocks have had a fairly choppy week, which makes the weekly close more important. A higher weekly close will be a positive sign, and the very strong action in crude oil on Thursday is a bullish signal for stocks.


As discussed previously, crude oil futures often break up or down ahead of the stock market. Wednesday's heavy selling in stocks increased the possibility of a deeper stock market correction, and while crude oil was also lower, it made new rally highs on Thursday.


The crude oil market is suggesting that the U.S. economy is stronger than most economists believe. This and a turnaround in the emerging markets would signal a sharp uptick in demand and a further surge in prices.


As a result, energy stocks or ETFs should be part of your portfolio. These two stocks are close to completing reverse head-and-shoulders bottom formations and have good upside potential.

Click here to enlarge


Chart Analysis: The weekly chart of crude oil shows the powerful rally from the early-October low as crude oil held above the major 50% retracement support.

  • The close above the September highs on Oct. 24 completed the double-bottom formation
  • Crude oil has next key resistance in the $100 area, which is the major 61.8% retracement level
  • Once this level is overcome, there are further targets in the $104-$106 area
  • The weekly on-balance volume (OBV) broke through its short-term downtrend, line b, ahead of prices. This was followed by a move through major resistance, line a, two weeks later
  • There is now initial support at $93-$94.50 with stronger support in the $90 area

The Select Sector SPDR - Energy (XLE) has just pulled back to retest the breakout level at line d. There is key support at $66.34, which was the Nov. 1 low.

  • On a move above the recent highs at $73.17, there is further resistance in the $74-$75 area and the daily Starc+ band
  • The longer-term trend line resistance is at $78-$79, line c
  • The relative performance, or RS analysis, broke its downtrend, line e, on October 18. The RS is above its moving average and both are rising nicely
  • The weekly RS (not shown) is above its weighted moving average (WMA) but has not yet broken out above major resistance
  • The daily on-balance volume (OBV) completed its bottom formation when it moved through resistance at line f
  • The weekly OBV (not shown) is testing its moving average and needs a higher weekly close to complete its bottom formation

Cobalt International Energy (CIE) is a $4 billion oil drilling and exploration company that hit a low of $6.30 on Oct.4. CIE traded as high as $17.22 in April.

  • The daily chart shows the formation of a reverse head-and-shoulders bottom formation with the left shoulder (LS) having formed in August and the head in October
  • The sharp drop on Nov. 1 and the low of $8.80 is tentatively labeled as the right shoulder (RS)
  • Though there was a volume spike at the right shoulder, the overall volume was highest going into the left shoulder and was lower at the head and RS
  • This is the volume pattern that one would expect to see in a reverse H&S bottom
  • The daily OBV has corresponding key resistance at line a. The weekly OBV (not shown) is positive
  • A close above the neckline at $11.65 would complete the formation and give upside targets at $16.65
  • Minor support now stands at $10 with stronger support at $9.40-$9.60

EXCO Resources (XCO) is a $2.7 billion independent oil and natural gas company that spiked to a low price of $9.33. It traded at over $21 earlier in the year. The daily chart of XCO looks quite similar to that of CIE.

  • The neckline of the reverse H&S bottom formation is at $13.55
  • The right shoulder low at $11.07 is quite a bit lower than the left shoulder at $11.81, but that often happens
  • A close above this level (preferably on strong volume) will give upside targets in the $17.80 area
  • The daily OBV is still in its downtrend, line b, while the weekly OBV (not shown) did form a positive divergence at the October lows
  • There is initial support at $12-$12.40

What It Means: Crude oil’s action and the fact that the Advance/Decline (A/D) lines have turned up nicely suggests that Wednesday’s drop was just to shake out some weak longs. On Wednesday, I allowed for a deeper correction if the Spyder Trust (SPY) violated the support at $122.78, but the low was $122.86.


A higher close for the week should set the stage for a push to the upside in the next week, and these two energy stocks are expected to participate. Though I generally do not advocate anticipating the completion of chart formations, for these two stocks, the risk/reward seems favorable.


How to Profit:


For Cobalt International Energy (CIE), buy at $10.18 with a stop at $9.29 (risk of approx. 8.7%). On a move above $12, raise the stop to $9.90.


For EXCO Resources (XCO), buy at $12.31 with a stop at $11.36 (risk of approx. 7.7%). On a move above $14, raise the stop to $11.86.


For the Select Sector SPDR - Energy (XLE), buy at $69.24 with a stop at $65.56 (risk of approx. 5.3%).


Our earlier recommendations to buy the United States Oil Fund (USO) and Sunoco (SUN) were not filled and those orders should be cancelled at this time.


Previous buyers of Noble Corp (NE) should be long at $29.56. Raise the stop from $27.08 to $32.90.


16Comments
Nov 11, 2011 9:43PM
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@ KFC40, if it is simple supply and demand, then demand that anyone who purchases oil stocks take delivery of it. Why don't the Oil Companies just come out and say they are the Grinch that is going to steal Christmas?
Nov 11, 2011 4:19PM
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Investing in those oil companies is great, research and go for it.

Speculating in oil itself is just going to drive our economy back into the dumpster.

Nov 12, 2011 11:37AM
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I agree, KFC 40 doesn't have a clue about the oil futures market.  It is manipulated beyond belief and its rise and sometimes fall really has nothing to do with supply and demand.   Over the past 3 years, most gas stations in the US have seen about a 20% DECLINE in the gas they have pumped due to unemployment and more fuel efficient vehicles.  The oil companies have recently stated they made record profits because of high prices and actually pumped less oil. There are two basic ways the manipulation of the oil futures markets can be corrected that will actually consider supply and demand, as well as the value of the dollar.  First,  make traders actually pay for buying an oil futures contract.  No more margin (credit) buying.  If they have to put their own skin in the game, it will stabilize the market somewhat.  Second, if you buy an oil futures contract, you will have to take delivery of the product.  This is the better way and will eliminate the greed and speculation.  Unfortunately, a lot of our Washington politicians are bought and paid for with oil money. 
Nov 12, 2011 1:09AM
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There is nothing that can be done in a reasonable sane method to stop the raping of us consumers by the Oil Industry except if Obama and the government of the people and for the people enact a nationalization of all Oil and gasoline pricing to be standardized which would equate to having one set price at the pump for the three type of gas grades. This crazy azz equation the oil industry uses to decrease the prices at the pump is purely pathetic  as crude oil and the brent could fall by $10.00 and it would take a month for the decrease in prices to go into effect, but on the other hand, if oil rises a single dollar in one day, immediately the price at the pump increases. I take my hat off to Obama for at lease releasing the reserves, but all the oil industry did was say, we are increasing the price cause the reserves are low. Obama did this a while back and the reserves should now be up to their previous levels with demand worldwide diminishing, but the oil industry still is producing at regular intervals and still charging more. How much more do these oil azz holes think we consumers will take before we storm the stations, or maybe they think just because we need gas, that we are to dam timid to attempt to do anything. Enough of this sh*t. It's time to fight back and fight back hard. If the government can not and will not do absolutely nothing, then maybe it'd time, We the People stand up and grow some balls and take matters into our own hands. I am not taking some violent radical approach to solving this insanity, just saying that we must do something today before the oil industry think we the consumers just have our fingers up our azz and sit on them waiting for us to fart and blow up.
Nov 11, 2011 11:48PM
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This is total stupidity on the speculators part and it will come back to bite them. There is nothing in our current economy to support prices at $100 a barrel. Once again, consumers will cut back on spending and that will halt any recovery that we have going. All boils down to Greed.
Nov 11, 2011 11:28PM
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So lets see, oil demand goes down, the price per barel can even go down, and yet the price at the gas pump still goes up....  That's not simple supply and demand, and people do have reason to ask if price speculators are effecting the market in this.
Nov 12, 2011 2:40AM
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Well once again I see the  SPECULATORS ARE UP TO THEIR SAME OLD CRAP AGAIN! It's such a shame that the bought and paid for politicians we elect to protect us from BS like this dont have balls enough to take speculation out of futures trading. But because big oil loves these f-ing little criminals so much for driving up prices and padding thier pockets they will continue to spend billions funding lobbyists to buy off everyone that could easily put an end to it. GET RID OF FUTURES TRADING PERIOD!!!! And at the same time close the Enron loophole so we can get some sanity and stability back into the energy sector of the stock market. SANTA, all myself and my baseball bat wants for Christmas this year is 5 min alone in a room with a few oil futures speculators! PLEASE!!!
Nov 11, 2011 5:49PM
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why  do  you people keep messing  with  the dam  oil  knowing  that  it  drives  up  prices  on  ever  thing  ?  or is it  that you don't,t  give a  dam   it's  ok  to  play  the  stock  market   if  your  that  dam stupid  but  keep your  greedy  dam  fingers  off  the things  that  people  has  to  have  every  day  .  there  again  you  don't,t   give  a  dam  as ling  as  your  stinking  bank  gets  fat  on  other  peoples last drop of blood   you  go  ahead  and   rob  and  steel   horde  money  but   one  thing  for  sure  you  won't  take  with  you  when  you   leave  this  world   you  will  leave  it  the  same  as when  you  come  it    WITH  NOTHING 
Nov 12, 2011 8:44AM
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PLAY! That's exactly what they're doing with peoples lives! Playing with them for their own advantage and not caring how it effects others. Greed pure and simple. STOP IT! 
Nov 12, 2011 3:56AM
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And if you buy into that logic, gas will hit $4.50/gallon by next summer!  Don't buy into this speculation garbage as what they are trying to do is get you to invest so they can sell at a profit!

 

Are we catching on to this game by now?  You Betcha!

Nov 12, 2011 7:08PM
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johnb26 is absolutely correct in the statement if you buy a futures contract you MUST take delivery!  This would take ALL the speculation on out for the greedy son of a bleeps that don't give a flying bleep about you and I!

Nov 12, 2011 10:40AM
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correct me if I am wrong, but the price of oil and hence gasoline and its derivatives are based on market forces?  So rather than have a straight forward concept of this($amount) is what the oil companies are selling it at, and this is what people pay ( with the exclusion of taxes and what not).  Like say a vendor has 100 oranges and charges $1 each.  If people play the market they can artificially increase the price and it has little to do with supply and demand?  Or is it like say a seafood auction where they auction off a tuna to the highest bidder who can therefore sell it at a higher price?  Something seems a little off, but then again I'm no financial wiz. Can anyone clarify for me.
Nov 12, 2011 9:56PM
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Last year Ray Irani CEO of Occidental made 76.1 million, Embarrassedcorrect me if I'm wrong but I believe that's .076 cents per gallon times one trillion gallons just to pay Him. He made 1,771 time what a Rig Hand makes, it's this kind of wealth disparity that's driving up costs and keeping our economy stagnate, if Occidental would spread their profits to their workers instead of just one man people would start buying goods and services- creating demand -creating jobs. For capitalism to work the wealth needs to circulate, not just pool at the top.Gift with a bow
Nov 12, 2011 11:46AM
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what ever happened, when the dollar is stronger oil prices will retreat, freak in ****s always got a reason, obama and his freak in green crap that all it's done is put people out of work and bankrupt, fine job obama now the north east and west can freeze their **** off. things will go up again in the stores, god help us if they raised the prices twice already because of higher oil cost, so we can stick it to the people that need to eat and cloth themselves again with higher prices.
Nov 12, 2011 2:45AM
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KFC 40, YOU REALLY DON'T HAVE A CLUE!!!!

Nov 11, 2011 6:20PM
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Guys its simple supply and demand, why should oil be any different than anything else. Free market capitalism.  
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