Chart of the week: Time to play the Shell game?

With crude prices seemingly in freefall and bullish sentiment towards that market in extreme bear territory, is it time to take a hard look at the oil majors?

I follow the Daily Sentiment Index (DSI), which is a proprietary survey of professional US money managers who give their views on various markets and whether they feel bullish or bearish (or neutral) in the short term.

The DSI has been running well under the 10% bulls level on crude for some time, while hedge funds have been running a record plurality of short futures and options contracts on the CME (the exchange that world prices are keyed off). When the hedgies are heavily short a commodity, a massive short squeeze is an alluring prospect for contrarians!

And that occurs more often than you may think. Hedge funds are primarily herding animals and, therefore, trend-followers. At major trend reversals, they will generally be holding the hot potato as the music stops - that is when the fun starts.

During this bearish phase, the oil majors have been taking a hammering, but, unless they are destined for the bankruptcy courts, at some stage they will bottom out and present at least an excellent trading opportunity - if not a long-term investment.

Time to examine the charts. Here is the Shell weekly chart, showing how the shares hit the 1,350p level last week, which matched the 2008 low, and rallied off it into Friday's close:

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For seven years, the market formed one gigantic wedge shown by the blue lines. The lower wedge line broke in 2014 and heralded the severe bear market down to last week's low right back at the start of the wedge.

Incidentally, I have been showing a very similar multi-year wedge in Barclays in Chart of the Week, which is in an earlier stage of its decline towards the start of its wedge.

One of the key properties of a broken wedge is that the market often retraces the entire move from its start - and this was achieved last week in Shell. That means the market can now enter a counter-trend rally phase if it so wishes, having satisfied the minimum requirement for my downside target.

Of course, the market can move lower from here, but what are the odds? Here, I turn to the wave structure on the daily chart of the big wave down off the 2014 high at the 2,450p level:

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The market has moved down, keeping between my tramlines (both have multiple accurate touch points). Note the head fake last Wednesday - this is where the market pokes its head outside the trading channel for a day or two for a look-see down below, doesn't like what it sees and scoots right back up inside to the safety of the channel.

And on Friday, the market gapped higher. To me, this is a clear sign of selling exhaustion.

Outlook

The path of least resistance appears to be up towards my upper tramline. A break above that will send the shares towards my first target in the 1,800p area. I believe crude has not yet bottomed, but, when it does, the majors will move much higher and my initial target for Shell is 2,000p, with higher potential thereafter.

Update on Pearson

Last week, Pearson announced major job cuts (10% of their workforce) in response to its continually slowing US educational market - as well as yet another profits warning.

I have been following the share price down for many months and, on 4 January, this was the chart I posted, showing the market had hit my major downside target around the 700p level:

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The stand-out feature is the very wide opening gap down in October in response to a similar profit warning issued then. And that breakaway gap gave me my circa-700p target.

This is what I wrote three weeks ago:

With this evidence, it is prudent to take at least partial profits on shorts around here and place a protective buy-stop on the remainder in the £8.40 area.

Odds favour a sharp rally soon, but this will be counter-trend, at least until I see a particular wave pattern develop, which I shall report on here if it appears.

But once the rally gets a head of steam, a gigantic short squeeze should take the market to the £11 mark at least.

And this is the current chart, showing the sharp rally last week following the adverse news.

(Click to enlarge)

The market has moved above the short-term blue trendline in a display of forceful short-covering. Remember, the short interest is around 4% of the outstanding shares and there is plenty of room for additional covering to achieve my short-term 1,100p target.

Outlook

The large momentum divergence tells me that the rally could have legs, but, if the general market declines again, all bets are off. Taking profits three weeks ago pre-empted the current bounce.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.