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Yesterday’s circus in the oil market will probably lead to further declines in both crude oil and stocks, as several oil majors have violated key supports.

Crude oil’s failure to rally through first resistance, and the ensuing sharp downside reversal, has seriously weakened the outlook for the energy sector.

The Energy Select Spyder (XLE) was clearly the star performer in the first quarter of 2011, but failed to make new highs with many of the market averages in early May.

In last night’s report, Fasten Your Seatbelts, I noted that the major stock-market averages were very near critical short-term support and that they were moving in lock-step with crude oil. Later, I examined several major oil companies, all among the largest components of XLE, and they also appear to be completing significant top formations.

The completion of these tops in the energy sector will impact the S&P 500 and Dow much more than the energy-light Nasdaq-100. If we get a drop in the major averages to more important support, it will be important for another sector to step in and take over leadership. It could be the tech sector.

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Chart Analysis: The daily chart of the Energy Select Spyder (XLE) shows a completed head-and-shoulders (H&S) top formation, as the neckline support (line a) was violated last week.

• This week’s rally just tested the neckline before Wednesday’s sharply lower close. There is now key support at $72.90, which may be broken Thursday
• The minimum downside targets from the top formation are in the $70 area
• There are more aggressive downside targets in the $65 to $66.40 area, which also corresponds to the 50% retracement support and the rising 200-day MA
• The daily OBV violated its uptrend last week (line c), and has now turned lower from its declining WMA. I noted recently that the weekly OBV was starting to act weaker than prices
• First key resistance now stands at $76.80 to $77.50, with major feedback in the $79 to $80 area

Exxon Mobil (XOM) may be forming a weekly double-top formation, as the recent rally failed to surpass the February highs at $88.23 (line d).

• There is key support now at $78.80, and a break below this level would complete the double-top formation
• The 38.2% support is at $76, with the 50% retracement support at $72. The double top has downside targets in the $69 area
• The weekly OBV failed to confirm the recent new weekly closing high (line f) and looks ready to drop below its WMA this week. A break of support at line g will confirm that a top is in place
• The volume picked up on Wednesday’s drop, and the daily OBV (not shown) has dropped below its WMA
• Initial resistance is now between $84 and $84.50, with much stronger levels above $86

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