Now’s not the time to be buying oil stocks.
That time was last October, when buying “big oil” was perhaps the most contrarian trade in the market. At that time, we argued the oil sector looked ready to play “catch up” with the rest of the market.
Since then, the price of oil has rallied from less than $40 per barrel to more than $65. And, the energy sector – represented by the Energy Select Sector Fund (XLE) – is up nearly 100%.
That’s a remarkable move for an entire sector in such a short time. As a result, investor sentiment towards the oil sector has shifted from extremely bearish, five months ago, to wildly bullish today. Just about everybody is bullish on oil right now.
That means, of course, it’s probably time to be cautious.
The S&P Bullish Percent Index for the energy sector (BPENER) closed Friday at 100. It’s not possible for it to move higher than that. That means the next move has to be lower.
And, when the BPENER turns lower from an overbought condition it generates a sell signal. So, the energy sector is most likely to be lower a few weeks from now than where it is today.
Take a look at this chart of the BPENER…
A Bullish Percent Index measures the percentage of stocks in a sector that are trading with bullish technical patterns. It’s designed to measure overbought and oversold conditions. An index is overbought when it registers above 80 – meaning 80% of the stocks in a sector are trading with bullish patterns. An index is oversold when it drops below 30.
Since it’s a percentage, it’s not possible for the index to trade above 100. In other words, the BPENER can’t get any more overbought than where it is today.
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The blue arrows on the chart point to the last three times this condition occurred. Each time, the energy sector was lower a few weeks later.
XLE fell 8% in three weeks last May. It dropped 22% in six weeks last summer. And, the overbought condition this past January led to a quick 10% decline in just two weeks.
Of course, there’s no guarantee the current overbought condition will lead to the same sort of pullbacks we’ve seen before. But, it’s a pretty fair bet that any immediate upside from here is limited. So, there’s no real urgency to jump into the energy sector right now.
Traders should give the energy sector some time to work off its current overbought condition before putting fresh money into the sector.
We’ll likely have a better chance to buy energy stocks at lower prices in the weeks ahead.
Best regards and good trading,
How do you think the energy sector will perform for the rest of the year?
Let us know your thoughts – and any questions you have at – [email protected].