Why I Expect Oil to Rally When Everyone is Bearish

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This is a chart of crude oil with Commitment of Traders positions below the price chart.  I wanted to give a little more detail on my perspective on the energy complex.

Of note on the large speculators positions, they have gotten progressively more short until early December which is their normal pattern.  They are the money that drives speculative trends.  Interestingly however, as price began to accelerate down ever faster at the beginning of December, the large specs have not increased the short position.  At this point there is a bullish divergence in the positions.  So crude oil has fallen 33% without the large specs increasing their short position.  This type of divergence is pretty classic as a trend ending pattern in underlying positions.

For basic understanding, first realize that the money that drives trends comes from somewhere.  And when the biggest money that there is, which drives the price trends, no longer follows the trend, the implication is that they do not have any more fund capacity collectively to participate in or push that trend.

So we have certainly ample evidence of that with a multi week massive decline but no further shorting by the large specs.  Additionally, there is now in the last few weeks at least a modest return to the normal commercial/smart money pattern of buying as prices decline.  So that indicates to me that the very directional commercial capitulation stage of this decline is likely waning.

Additionally, the daily MACD is demonstrating bullish divergence, and the money flow index is demonstrating pretty classic reversal divergence.  The money flow index basically looks at price and volume and typically demonstrates a substantial lead time with prices.

Taken together, it appears to me that energy prices (including natural gas, heating oil, gasoline) are likely to stage a rally very soon.  Whether or not it will be a bear market rally I don't know.  I would lean towards believing that because of no weekly time frame MACD divergence currently at these lows.  I think it will more likely turn into a volatile basing period or a rally followed by a failed breakdown to new lows before prices may bottom longer term.  But that is looking out kind of far for my purposes.  Really I am just interested in catching the next swing up, which I expect to be quite swift given the major oversold condition of this market.

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For those more interested in equities, this is XLE which is a major ETF covering oil and energy related stocks.  Notice how it has not maintained the aggressive decline that oil has.  And it also is displaying a drawn out bullish divergence on the MACD with a more classic chart pattern bottom with a failed breakout below the December 16th low, followed by an immediate reversal higher.  This indicates a stop running move in the market and that the buying interest was picking up right at that low as other (dumb money) was selling out or shorting in the break.  This makes the dumb money about as wrong as possible and the smart money about as right as possible.

For trading purposes the XLE etf may be a better purchase or near term speculation than crude oil itself.  That remains to be seen, but just understand there are several ways to participate in this probable reversal.