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Technical indicators may seem arcane at first glance, but they can be a valuable tool in the crude oil trader’s toolbox.
That’s because their precise, empirical nature can help filter out market noise and help traders clarify price action, leading to improved decision-making when placing trades.
In this article, we will explore five technical indicators popular among oil traders and how they can help you improve your trades.
Why use Technical Indicators when Trading Crude Oil?
But first, let’s take a quick look at the value technical indicators can bring to oil traders.
Like any commodity, crude oil prices are primarily driven by supply and demand levels. However, because crude oil is an essential commodity, supply and demand are influenced by a myriad of geopolitical, macroeconomic, and even weather factors. This makes analysing supply and demand levels a highly complex task.
Technical analysis strips out all other data points and focuses solely on price action. The belief is that anything significant enough to impact the market is already priced in, so everything else is just noise. Thus, when applied to the highly complicated nature of crude oil markets, technical analysis can offer a refreshingly clear alternative perspective.
By focusing on price levels as recorded on a price chart, a trader can use technical indicators to decipher what happened and make an educated guess on what might happen next. Furthermore, because brokerages provide real-time market data, technical analysis can spot and confirm price trends in real time. This offers an invaluable advantage to short-term strategies such as day trading.
However, technical indicators aren’t completely foolproof. Their proper use requires understanding how they work and what they are measuring. Also, it is important for crude oil traders not to be too fixated on their technical analysis, as this can leave them unprepared for unexpected market events.
The bottom line is: Technical indicators can be highly useful to crude oil traders. However, given the nature of commodities, traders should not completely disregard fundamental analysis.
1. Momentum Oscillator
A momentum oscillator measures the strength of a directional move in price. It allows oil traders to gauge, for example, the strength of a price breakout, which affects the likelihood that the trend will continue.
There are many types of momentum oscillators available, with popular ones being Moving Average Convergence Divergence (MACD), Relative Strength Index (RSI), and stochastics.
Momentum oscillators can help crude oil traders quantify the strength or weakness of short-term trends and identify reversal and exhaustion points on a price chart. As such, they are ideal for day trading, breakout trading, and other short-term strategies.
2. Moving Average Convergence Divergence (MACD)
The MACD is a popular technical indicator that can be highly useful when read correctly. A type of momentum oscillator, this indicator excels at identifying changes in momentum and trend.
This is quite an advanced indicator, as it requires some understanding of moving averages.
How it works
Essentially, the MACD consists of a pair of lines and involves reading how they interact. The first line (MACD line) is derived from subtracting the 26-day exponential moving average (EMA) from the 12-day EMA. The second line (signal line) is the 9-day EMA of the MACD line.
The MACD indicates bullish and bearish signals; here’s how: When the MACD line crosses over the signal line, a bullish signal is indicated, meaning that oil prices are trending upward, creating a potential opportunity to take a long position.
When the MACD line crosses under the signal line, a bearish signal is indicated. This means that a bearish trend is forming, potentially indicating an opportunity to consider a sell position.
3. Relative Strength Index (RSI)
Another popular momentum oscillator, the RSI, is favoured for its simplicity and beginner-friendliness.
It indicates overbought or oversold conditions in the crude oil market by comparing the magnitude of recent gains to recent losses. In this way, the RSI can be used to signal potential entry or exit points and to gauge market sentiment.
How it works
The RSI is calculated by dividing the average gain over a specified period by the average loss over the same period. The result is plotted on a scale of 0 to 100. Generally, when the RSI is at 70 or above, an overbought signal is indicated (price is high), and traders might want to get ready to sell.
When the RSI is at or below 30, an oversold signal is indicated (price is low). This could suggest a potential buying opportunity.
If available, the shading under the RSI indicates trading volume – the darker/more intense the shading, the higher the trading volume for the period. This can be used to decipher market sentiment.
4. Support and Resistance Levels
Support and resistance (SR) levels are another well-known category of technical indicators. Some of the more widely used SR levels are Bollinger levels, Fibonacci Retracements, and moving averages.
How it works
SR levels are chart areas that technically constrain how high or low the price might go. They are plotted based on precise past points on the price chart and thus provide a basis for predicting immediate trends and setting stop-loss or take-profit points.
When used in a price chart, support and resistance levels indicate the range of oil prices at which the market is currently trading. They are often extended to extrapolate future price ranges.
The Line of Support indicates the lowest price point during the trading day, while the Line of Resistance shows the highest price seen during the day. When the price breaks above or below the SR lines, this may indicate that a new price trend (and SR range) is on the horizon.
5. Bollinger Bands
Bollinger Bands is a technical indicator invented in the 1980s by financial analyst John Bollinger. This tool is designed to measure volatility, helping traders to spot overbought or oversold conditions.
When plotted, Bollinger Bands overlay the price bars on a chart. It is composed of three lines – a simple moving average (the middle line) and two standard deviations that make up the upper and lower lines.
How it works
The distance between the top and bottom lines indicates how volatile the market is – widening during high volatility, and narrowing during low volatility. Meanwhile, the middle line can be used to gauge price trends. When the middle line slopes upwards, an uptrend is indicated, and vice versa.
Additionally, when the price nears or exceeds the upper limit of the band, it could indicate crude oil is overbought, suggesting a selling opportunity. As the price nears or exceeds the lower limit of the band, crude oil markets may be oversold, and there may be an opportunity to consider a buy position.
Conclusion
Technical indicators can help traders decipher complex information, spot trends, and potentially find trading opportunities. They can be valuable tools in the hands of skilled traders and are worth learning for any trader interested in technical analysis.
These five tools we’ve introduced are just the tip of the iceberg. As you trade, you’ll discover many more variations and advanced indicators that offer alternative ways to understand the crude oil markets.
One thing to remember, though, is that no technical indicator is foolproof, and the market could move in an unexpected manner. It is advisable to learn a range of different indicators and use them together for greater confirmation.
Most technical indicators can be customised using different moving averages and other parameters. As your familiarity with technical analysis grows, don’t be afraid to tweak your favourite indicators to better fit your own strategies.
To learn more about technical analysis, visit the Vantage Academy or start using these indicators with a live trading account today.
