This article was published in Business Times’ column “Chart Point” on 15 January 2018.

WTI crude oil vs COT Non-Commercial Futures positions Monthly Chart                                            Source: Bloomberg, PSR

*red highlighted box shows the period where the record long bets in the Non-Commercial group led to long squeeze

*red line = 60 month moving average

For the past four months, West Texas Intermediate Crude (WTI) oil has made remarkable progress to the upside. Despite the recent rally, we believe there might be limited upside ahead as the confluence of 60-month moving average and 62.58 resistance area stands in the way.  As WTI oil tests the critical resistance area, a reversal lower is expected with the extremely concentrated long bets showing up on the Commitment of Traders (COT) Non-Commercial Futures positions.

Notice how reactive WTI oil is to the 60-month moving average since June 2009 shown by the grey highlighted areas. There seemed to be a special relationship between them, making the 60-month moving average a crucial signal to watch. A general rule of thumb for the existing uptrend to remain intact is to have price staying above the 60-month moving average, vice versa. For example, after WTI oil price closed above the 60-month moving average (67.80) in June 2009, the uptrend was confirmed. The subsequent moves higher were all supported by the 60-month moving average shown by the grey highlighted areas even though there were some intra-month lows below the 60-month moving average. The closing price for the month is all that matters. In total, there were 19 occasions where the 60-month moving average defended the uptrend successfully. This pattern lasted until September 2014 where the sellers finally managed to close price below the 60-month moving average (91.37). As a result, the prior uptrend was reversed to the downside significantly. It took the bears a whopping five years before shifting the trend around to the downside.

With the help of the OPEC and Russia to extend the oil cut to the end of 2018, WTI oil succeeded in breaking above the 60.00 psychological barrier. However, the recent rally has also lifted price back to the pivotal point of 60-month moving average. Moreover, the 60-month moving average also coincided with the May 2015 high of 62.58, making this a stronger resistance area. As long as WTI oil price fails to close above the 60-month moving average, the long-term downtrend should continue to weigh down on price. The January close will be an important month to watch to see if the bulls manage to close price above the 60-month moving average.

There were other important details in the current COT report. With the rise in oil price, it attracted more bullish bets on higher prices. The most recent reading of the COT crude oil net Non-Commercial Futures positions report has reached yet another new record high 624,000 contract. Non-Commercial traders tend to provide a contrarian signal when the data exceeds into the extreme zones (overcrowded trade). With so much consensus trade piling on to the same bet, long squeeze tends to happen. Long squeeze is the situation where buyers are forced to sell due to dramatic drop in price, leading to further selling by other overcrowded buyers. The overcrowded buying scenario can be seen by the Non-Commercial Futures position breaking into new record highs.

For example, the excessive bullish bets in July 2014 and March 2017 where the Non-Commercial Futures positions entered into all-time high at 459,000 and 525,000 contracts respectively. As soon as some market weakness appeared, long squeeze took place as the vulnerable bulls are forced to sell. During both episodes, the long squeeze led to a 55% and 16% selloff. Other examples of long squeezes are shown by the highlighted boxes.

Hence, with the excessive bullish bets on WTI Oil and price testing a pivotal point at the confluence of 60-month moving average and 62.58 resistance area, WTI oil should be forming a near-term top and enter into a period of correction soon. A retest of the 59.00 support area is likely followed by the 55.00 range. Keep in mind the Daily and Weekly Relative Strength Index (RSI) are both overbought as well at 75, pointing to the same conclusion of a correction to the downside soon.