Heating Oil: A Disconcerting Chart

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

By Scott Pluschau for ETF Digest

NEW YORK ( ETF Digest) -- If you live in the Northeast and heat your home with heating oil, this is a chart for concern. The bearish mood in heating oil futures has been wiped out today. A bearish "head and shoulders pattern" formed in heating oil over the last three months. After breaking down sharply from its right shoulder, it rallied off its lows into a consolidation pattern that I marked with a blue rectangle. See chart above.

A rectangle, such as this, is a combustion chamber of energy due to the tight opening and closing ranges that happened consecutively for multiple days. This causes tension to build in the leveraged positions of open interest. In futures, open interest is a contract between a buyer (long) and a seller (short). Breakouts from congestion areas like this are propelled by the losing side of the open interest scrambling to cut their losses quickly and close out their trades.

The tight ranges in this congestion area are easily visible with candlestick charting, and it is a great reason to use them. When you look at Japanese Candlestick charts, there is a body of the candle and there is sometimes what is known as wicks.

The body of the candle can be appearing as just a dash, or it can be hollow, or filled with the color red or black. This body of the candle represents the price range extension between the open and the close for that trading day. The wicks, also known as tails or shadows, are the high and low range extension for that day and are signs of indecision or price rejection.

Heating oil blasted off of this rectangle to the upside today in a big way, which can be clearly seen with the long-range bodied candle. The hollow body outlined in black represents a close above the open, and above the prior day's close. This is a very bullish single continuation candlestick pattern.

That right shoulder is now likely to become a magnet. A magnet is an obvious area where stop losses are most likely to be clustered and targeted by high frequency traders. For example, those who took short positions on the breakdown of the head-and-shoulders pattern might be exiting their trades by buying in here. This would cause an additional increase in demand. From a charting perspective, once we are above that right shoulder, the path of least resistance is likely going to be higher.

The big question is this: Are the long positions that were put on recently going to be handed off to the buy stops that are being executed to close out losing short trades for a profit? Picture a dump truck backing up and unloading inventory.

A long trade being closed out at a profit to a short trade being closed out at a loss would decrease the current open interest. Perhaps it is strong-handed buyers who are not going to be selling for profit, but are hedging themselves for the longer term?

I will be looking closely at the Legacy Commitments of Traders report in heating oil the coming weeks. The COT report is put out weekly by the US Commodity Futures Trading Commission and it shows the positions of the commercial traders (hedgers), non-commercial traders (large speculators) and the non-reportable (small speculators) along with the changes in open interest.

There is an ETF for heating oil by the symbol ( UHN).

In full disclosure I have no position in UHN at this time.

Follow this writer on Twitter: Scott Pluschau

Comments or questions on Auction Market Theory are welcome scott.pluschau@etfdigest.com

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Scott Pluschau was a financial advisor with Citi. His technical analysis report on the Nasdaq Composite Index was featured by Dr. Marc Faber in his June 1, 2011 Gloom, Boom & Doom report. Scott earned his degree in Accounting and Taxation from Pace University. He lives on Long Island with his wife Ilona, daughter Olivia and son Henry.

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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