Where Crude Will Go From Here

Let's take a look at crude oil's chart today in the context of the February futures contract, which will expire a week from today. The last trade in February crude-oil futures is Jan. 20, and the final notice is Jan. 24. That means that the volume will roll to March a week from now, and the contract will be completely closed out by the following Wednesday.

Often, trends in crude tend to reach extremes at or near the monthly expiration of the futures contract, at least since the accelerated uptrend began in 2004.

That's probably because the traders in this market have been trend traders, jumping on the momentum train and riding it as long as they can. Those who have tried to fade this market as the monthly expiration dates approach have found the momentum too strong, and they have ultimately been squeezed out of their "fades" heading into those expirations.

This chart shows an indicator called the vertical-horizontal filter, or VHF. This indicator measures the absolute value of the chart's vertical movement relative to the absolute value of the sum of its daily changes over a particular period (in this case, 21 days -- here used because that's a month's worth of trading days).

Light Sweet Crude

Source: The Agile Trader

In other words, when the VHF line is very high, the trend (in whichever direction) is very mature. When the VHF line is very low, the market has consolidated over the 21-day period. To repeat, the VHF line is a measure of the maturity of the trend, irrespective of the trend's direction. So the VHF line is high when the trend is mature, either to the upside or the downside, and low when the market has consolidated the prior trend, whether that trend was to the upside or downside.

The yellow highlights are drawn wherever the VHF line has turned down from a very high level. As you can see, from the beginning of 2005, those yellow highlights were showing up just before important local tops. But in September 2006, that behavior reversed. The right-most yellow highlight showed up as a momentum climax of a downtrend approached.

And now we are seeing a high VHF reading on another sell-down.

The current downtrend is now maturing as we approach next week's expiration event. I'd be looking for this market to begin bottoming near the end of next week, probably in the $48-$50 area. This bottoming is likely to be a process and not a solitary event; it will probably take some time and have a rounded or "W" shape rather than a "V" shape.

That $48 area is near the lower green highlight on the chart, which represents the February 2005 gap up -- a gap that was never filled and that is likely to get filled before this decline is over.

Once crude stabilizes and begins to bottom, the Nasdaq Composite and NDX may well give up their leadership roles, at least in the near term, as money rotates back into energy.