The Best Long and Short Plays of the OIH

Despite near-term bearishness, the energy sector's broad diversity ensures that some components will keep on posting new highs, even if crude oil heads back to two-month support at $80. In that event, I would favor well-established oil services companies and small independent explorers that can trade against the falling tide.

Numerous studies confirm that most energy stocks will follow broad market direction over time, rather than running in lockstep with the futures pits. So last week's downturn in the S&P 500 index, if it continues, will add to selling pressure in the energy complex as we head through November.

Major integrated oil stocks might lead the downside in coming weeks. Industry leader Exxon Mobil dropped to 27th in the Dow 30 performance list after posting weak earnings on Thursday. Notably, the selloff broke the neckline of a six-week head-and-shoulders pattern, as well as support at the 50-day moving average.

The target for this decline lies at 200-day moving average support below $84. In this regard, any bounce that presses up into new resistance between $90 and $91 should be viewed as a short-sale opportunity. Longer-term support suggests that level will mark the final low before the start of a new upturn in 2008, so this is just a trading call.

Pay close attention to natural gas prices as we enter the coldest months of the year. That futures contract has pressed up to an 11-month high and is now testing resistance at $9. The long-term chart for this instrument is fascinating, because it opens the possibility of a vertical spike similar in appearance to the 2005 parabolic rally.

It's no stretch to assume that energy players may take profits in crude oil futures and pile into natural gas, in hopes that rally lightning will strike twice. But this type of event will need a hot spark to get it going. That means waiting for a change of heart from a certified weather guru, like Accuweather's Joe Bastardi, who still expects a warmer-than-normal winter.

It's best to stick with the natural gas sector's biggest names if you're interested in playing a run-up this winter. Southwestern Energy is the obvious pick in this regard. The stock rallied to a new high at $50.62 in June, in the latest leg of a seven-year uptrend. It broke out above resistance on heavy volume last week after reporting strong earnings.

Long-time readers know I don't recommend chasing vertical rallies, and this is no exception. The chart shows very strong support between $51 and $52, so this is the obvious place to look if you want to get on board. With options expiration coming up in another week, that time period could trigger a shakeout that drops price right into your portfolio.

The Oil Services HOLDRs Trust ETF is still holding the mid-October breakout to new high, but just barely. The exchange-traded fund has dropped below support at $191 in five of the last 11 trading days. This is yielding mixed messages that leave the instrument in the hands of short-term traders. Everyone else should just stand aside and wait.

Note how the rally spiked through $200 for four sessions and sold off sharply. It looks like the fund has moved into a holding pattern while crude oil deals with round-number resistance at $100. For obvious reasons, these big levels will mark reload points for institutional short-sellers until the instruments break free, or a downside reversal sticks.

We've established the Trust is a trader's market for now, so let's identify the best long and short plays among its fourteen components.

Noble Corporation isn't the strongest member of the fund, but it does show the best-looking breakout pattern. The stock rallied to a new high at $54.28 in July and rolled over with the broad market. It bottomed out in August and started to recover. Price returned to resistance on Oct. 26 and sold off early last week.

That decline found immediate buying interest, with price surging higher and closing less than a point off its high on Friday. This sets up the possibility of a major breakout sometime this week. Accumulation looks very strong on this issue, indicating that price could rally up to $60 before the next pullback begins.

Schlumberger was an energy-sector leader until mid-October, when it rolled over from an all-time high and dropped 10 points in just six sessions. The stock bottomed out at $94.77, well below 50-day moving average support and has been hugging the underside of resistance for the last two weeks.

Look for an obvious failure day, in which price surges above the 50-day moving average and then sells off on higher-than-normal volume. That would mark the signal for short-sellers to start building positions for a takeout of the October low and selloff into 200-day moving average support in the mid-$80s.