As Oil Crashes Under $40, How Much Further Can It Drop

Well that escalated quickly. Having toyed with the $39-handle yesterday, this morning's plunge has erased those stops:

 

... and WTI is set to test the early April lows on the way back to 2016 lows...

 

What is next for oil now that key support is broken?: some thoughts from BofA's chief technician, Paul Ciana:

Oil has reached the triangle top target (40.80) we reported on in early July. Today oil is extending its decline, breaking the 200d SMA and testing support at the round number of $40. Short term measurements shown in Table 1 and Table 2 suggest oil could bounce this week (as much as a 65% possibility) and test resistance at $43.18 or $44.50. However that bounce may be short lived and we think sold. The weekly chart shows momentum isn’t oversold yet and deeper Fibonacci retracement levels at $38.86 and $35.84 could be reached as a larger oil market bottom pattern forms. Oil in the mid $30’s which is near the 61.8% retracement and bottom of the weekly Ichimoku cloud would be a more technically convenient long trade scenario.

 

Price action has moved to the center of the weekly Ichimoku cloud. The cloud offers support as low as $35.40 and resistance at $44.32. If price were to reverse higher between here and the bottom of the cloud then we could see a potential head and shoulders bottom forming. If the decline were to accelerate lower and break the bottom of the cloud, then a double bottom pattern could form.

 

The below chart shows crude oil’s five, ten and thirty year average trend normalized to the start of the year and compares it to the current year in black. The pressure on crude oil prices is generally down from August through early December giving plenty of time for a right shoulder or double bottom to develop.

 

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Finally, why is the breach of $40 important? We go back to what Marko Kolanovic said in the remainder of his note earlier today:

While US momentum is positive across the board—and S&P 500 exposure of CTAs likely is at record level—negative momentum in Europe and Japan require a short position in these equity markets. CTA signals for oil recently turned from strongly positive to moderately negative. This has contributed to past-month divergence between S&P 500 and oil (~1.5 standard deviations) and is closely monitored by equity and high yield credit investors. It is our view that the risk of CTAs significantly increasing oil shorts over the next 1 month is low. For oil momentum to further deteriorate, oil would need to drop to ~$30 at which point the medium term momentum (strongest signal) would turn negative and trigger selling.

Look forward to today's API report to add to the volatility.