Are Crude Oil Prices Due to Bounce After Recent Weakness?

Last week, WTI crude oil futures prices recorded a value of 29 on the daily Relative Strength Index (RSI-14) indicator, which is considered to be short-term oversold. The RSI-14 remained in this oversold condition for just one day; looking back at historical data, when the RSI-14 is oversold for short periods of time (i.e., less than five trading days), there tends to be an increased likelihood that crude oil prices may bounce and move higher.

The RSI-14 is an internal indicator that measures the speed and change of price movements in the form of a momentum oscillator. The RSI-14 oscillates in between 0 and 100, whereby a value over 70 is considered overbought and one below 30 is considered oversold (see the figure below). The term “oversold bounce” refers to a rally in prices that occurs after a sell-off that is perceived as too severe or overdone.

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On August 2, the daily RSI-14 triggered oversold conditions with a value of 29; it stayed in oversold for only one trading day. The length of time a security or index remains in oversold territory is important. Looking at historical data going back to 1997, when the daily reading on crude oil’s RSI-14 went below 30 (i.e., oversold) for less than five trading days, subsequent prices tended to rise.

Since 1997, this happened only 16 times. Three months later, crude oil prices were higher 81% of the time, with average and median returns of 9.4% and 4.9%, respectively. Going out six months, the returns are higher 75% of the time, with average and median returns of 14.7% and 14.1%. Looking out one year, the returns were higher 69% of the time, with average and median returns of 19.1% and 16.8% (see the table below).

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As crude oil (WTI) prices have moved approximately 26% lower over the past two months—creating a short-term and short-lived oversold condition on the RSI-14—one bright spot is that the speed and rate of change of this downward price move may have been too severe, increasing the potential for an oversold bounce.

GLOSSARY OF TERMS
Relative Strength Index (RSI-14) oscillator is a momentum oscillator which measures the rate of the rise or fall in price.  It is typically used over a 14-period look back time period and measured on a scale from 0–100, with overbought levels marked above 70 and oversold levels marked below 30.

Oversold condition:  This term identifies a scenario in which the price of the security or index has moved too low and too fast reaching an extreme limit, increasing the likelihood that the price moves higher in the form of an oversold bounce.  Oversold conditions can be measured using the Relative Strength Index (RSI(14) technical indicator.

Overbought condition:  This term identifies a scenario in which the price of the security or index has moved too high and too fast reaching an extreme limit, increasing the likelihood that the price moves lower in the form of a pullback.  Overbought conditions can be measured using the Relative Strength Index (RSI-14) technical indicator.

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