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Technical Analysis of Oil ETFs by Brian Hoffman

XLE & XEG ETF Technical Analysis

picture-brian-hoffman1I am pleased to have Brian Hoffman, CA, CPA, contributing to our site.  Brian writes regularly for Investors Digest, a weekly investment publication in Canada, on technical analysis of oil and gas companies. Brian is an affiliate of the Market Technicians Assoc. and a member of the Canadian Society of Technical Analysts (E-mail: bk.hoffman@rogers.com)

The Energy Select Sector SPDR Fund (XLE-NYSE) and the iShares CDN S&P/TSX Capped Energy Index Fund (XEG-TSX) are the most significant exchange traded funds (ETFs) to track the shares of oil and gas companies traded on U.S. and Canadian stock markets, respectively.  Specifically, the XLE ETF experiences a rather high volume of trading, recently about 40 to 50 million units per day.  This ETF has a heavy weighting of Exxon Mobil Corp. (XOM-NYSE), which significantly influences the direction of the ETF.

However, since XOM has performed better than the XLE ETF during the last several months the recent influence has been positive.  The XEG ETF has a much lower volume of trading, recently about 1.5 to 2 million units per day, and is the primary ETF that tracks the shares of Canadian senior oil and gas companies.

The comments below provide a technical analysis of these two ETFs in terms of the breakdown that occurred in their unit values last year and the current stock chart pattern that each ETF has formed.  There are several other ETFs that track the shares of U.S. oil and gas companies and their unit values have performed in a very similar manner to the XLE and XEG ETFs and have also recently formed similar stock chart patterns.  As a result, the comments on the XLE and XEG ETFs generally apply to other ETFs that track the shares of oil and gas companies.

Trend Line Breach

Looking back to the summer of 2008, the unit values of the XLE and XEG ETFs moved up significantly along with the ascent of oil prices towards US$147 per barrel.  Natural gas prices increased significantly along with oil prices, so the share prices of natural-gas-weighted exploration and production companies increased along with the share prices of oil-weighted exploration and production companies.

The significant upward moves in the share prices of oil and gas companies and the XLE and XEG ETFs were unsustainable, so decreases in the rate of the ascent was inevitable.  In terms of the trend lines for these ETFs’ unit values, they had support (see comments below for an explanation of support) along their five-year trend lines that was eventually breached last year.  Refer to the points marked A along the five-year trend lines for the breach in each of the XLE and XEG ETF charts below.  There was a slight lag in the trend line breach in the XEG ETF chart compared to the breach in the XLE ETF chart.

xle-etf-chart-hoffman

XLE

chart-xge-etf-feb-093

XEG

The XLE and XEG ETF unit values experienced significant free-falls after their five-year trend lines were breached.  These free-falls accompanied the general market decline, so the shares of oil and gas companies weren’t alone in the decline.  Anyway, from an oil and gas investment perspective, these breaches of the ETFs five-year trend lines were significant since these trend lines have now become resistance levels for the eventual recovery in the share prices of oil and gas companies.

A support level for the price of a security or ETF is the level at which buyers have become as powerful as sellers and stop a price decline.  Whereas resistance is the level at which sellers have become as powerful as buyers and stop an advance.

Stop loss orders to protect against declines in positions of the XLE and XEG ETFs would have taken investors out of these ETFs before the free-fall in their unit values gained momentum later in the year.  Don’t ever let the market cut the value of any of your positions in half.

Symmetrical Triangle Patterns

The stock charts for the XLE and XEG ETFs have now formed symmetrical triangle patterns, which are converging towards the points marked A in the charts below.  Breaches of the lower bands of support in these symmetrical triangles could result in further free-falls in the unit values.

xeg-triangle-5

A symmetrical triangle is a consolidation pattern that generally occurs after a significant increase or decrease in the value of a security or ETF.  Essentially, the market is trying to absorb the impact of the recent move before the next move begins, which could be either a continuation of the preceding move or a trend reversal.

At this time, breakouts from the XLE and XEG ETF symmetrical triangle patterns appear to be pending.  There is no general pattern for the direction that breakouts take for symmetrical triangles.  In general, a breakout is confirmed when the value of a security or ETF increases at least 10 per cent above or decreases at least 10 per cent below its resistance or support levels, respectively.  In the case of a symmetrical triangle, the 10 per cent move would be measured from the upper band of resistance or the lower band of support.

A breakout confirmed by a 10 per cent price movement is generally followed by a price move back towards the breakout zone, which is referred to as either a throwback or a pullback.  However, throwbacks or pullbacks don’t always accompany a breakout from a symmetrical triangle.

Volume generally declines during the formation of a symmetrical triangle.  High volume during a breakout normally enhances the extent of the move after the breakout.  Refer to the points marked B in the charts above for the declining trend in volume that has occurred during the formation of the symmetrical triangles for the XLE and XEG ETFs.

In any event, both the XLE and XEG ETFs appear to be close to the points at which their unit values may experience breakouts.  With oil currently trading below US$40 per barrel it is hard to imagine the direction of their breakouts occurring to the upside.



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