Crude oil: WTI correction a healthy development for longevity of the bullish trend

* WTI crude down 7% in three sessions

* Fundamentals remain bullish while near-term technical picture is bearish

* Price action around these levels could determine the scale of the current correction

Healthy bull markets need to breathe

One of the first lessons I was taught was that for bull markets to be sustainable, they needed to breathe occasionally, allowing fresh longs to join in whenever prices deviated a little too far from reality. In that context, the pullback in crude oil recently could be deemed a healthy development, correcting an unsustainable, one-sided trade which left the contract overbought and over-loved.

Bullish fundamental backdrop for crude remains in place

As is often the case, there have been no shortage of narratives to fit the price action, ranging from demand destruction from higher bond yields, potential supply disruptions in the Middle East being potentially resolved, along with fresh bearish forecasts from one analyst on the street. Perhaps they drove the reversal, but the fact the catalyst can’t be pinpointed suggests the rally simply ran out of bulls willing to buy.

But now we have better levels, will that remain that way given tightness in physical markets? Demand has held up even with higher prices while Saudi Arabia and Russia have already committed to curb oil production and exports until the end of the calendar year, seemingly suggesting the bullish fundamental picture remains much the same.

WTI price action today may determine scale of correction

Looking at WTI on the daily, prices have now fallen over 7% from the highs hit on Thursday, underlining the speed of the current reversal. With the fundamental picture remaining bullish but the technical picture bearish near-term, the price action around this level may be informative as to where crude is likely to head next.

A sharp dip below $88 in late September attracted solid buying, resulting in a bullish hammer pattern being generated on the charts. Sitting just below that level today, which also acted as resistance earlier on in the crude rally, you get the sense that today holds the key as to just how far this correction will play out.

Trade optionality for WTI around these levels

On the downside, there isn’t any significant visible support until we get back to channel support found just above $85. Given the proximity to a long-term support/resistance zone between $83.50 to $84.50, that would likely be the limit to downside in the absence of a sharp turn in the fundamental backdrop. On the upside, minor resistance may be found around $91. Beyond that, $92.40 and the YTD high around $94.60 are the levels to watch.

Depending on which way price evolve today, a stop-loss either below or above $87.80 to $88 will offer protection against the trade working against you.

-- Written by David Scutt

Follow David on Twitter @scutty