What does Crude Oil Trading involve?
The huge price fluctuations and high activity in the crude oil market make it attractive for day traders and long term investors alike. New investors may ask themselves how crude oil trading differs from other financial markets? In simple terms, the huge impact that price variations in the crude oil market have on world politics and economics makes it unlike any other type of commodity. Conversely, important events – such as the coronavirus – that affect global political decisions, can result in wild fluctuations in the global crude oil market. Supply and demand issues in major producing countries are perhaps more crucial to the stability of the market than in any other marketplace.
Why trade crude oil?
Because of the dominance of crude oil in industrial production and its importance in global politics, the crude oil market is always popular amongst investors. There are huge profits to be made by investing in the crude oil market, but the high volatility of the market also carries with it a high rate of risk.
Potential investors and traders need to understand the basic fundamentals of the crude oil supply and demand chain in order to successfully trade and make a profit. There are many strategies that investors use to gain from fluctuating oil prices. We’ll take a more in-depth look at some of the most common strategies used in the crude oil market further on in this article.
How to choose a broker and open an account
Finding the right broker is crucial to your success in investing in the crude oil market. There are a huge number of online brokers that advertise their services on the internet, but care must be taken to ensure that you choose a reputable firm.
A deep understanding of what moves the crude oil market is indispensable for a broker. A broker who does not have the right knowledge base or the commensurate experience with trading oil futures could easily provide you with unwise investment advice. Take note of past performance as this will indicate their level of success going forward. Ensure that the broker you select is properly insured and that they are certified by the appropriate regulatory authorities.
How to buy crude oil stocks
The most commonly traded form of crude oil is called light sweet crude oil. Light sweet oil trading takes place on the New York Mercantile Exchange (NYMEX). The three main types of crude oils that serve as benchmarks in oil pricing are the West Texas Intermediate Crude (WTI), the Brent Blend and the Dubai Crude.
Trading crude oil futures and options is a popular method. Basically, a futures contract involves agreeing to buy or sell stocks at a predetermined price. New investors should only invest using an experienced crude oil futures broker. Crude oil is also traded via CFDs (Contracts For Difference). Investors can also enter the market via oil exchange-traded funds (ETFs) or by purchasing shares in oil companies.
Leveraging in crude oil trading
Leveraging can be a highly powerful investment tool when used correctly, but this can also lead an inexperienced investor to quickly lose not only his money but the money of financial backers as well.
In very simple terms, leveraging is making an investment where part of the funds invested is provided by another source. Instead of buying the entire amount of a trade yourself, you borrow money from a financial institution or a brokerage firm to cover part of the trade cost.
Leveraging allows investors to make bigger trades with more purchasing power, thus increasing their potential profits but also increasing their exposure to risk. It is advised to only use highly experienced brokers when making leveraged trades.
Can you profit from crude oil trading?
The worldwide energy market rises and falls on the back of oil prices. As perhaps the most fiercely traded world commodity, trading in crude oil can be highly profitable. However, since the crude oil market is flooded with short-term day traders and long-term investors, in order to make a profit an investor must have the right skill set and experience in reading the market.
Strong and consistent returns are possible in the crude oil market, but only if you or your broker can anticipate and then take full advantage of price fluctuations. We’ll go into what you really need to know to make a profit from crude oil trading in more detail in the next section.
Tips for successful crude oil trading
There are three top tips to help you profit in the crude oil markets.
- Investors must firstly choose the right market: either the US West Texas Intermediate (also known as the WTI) or the London based Brent Blend Crude. Understanding the intricacies of these markets is crucial.
- Next, an investor must always stay informed of what moves the crude oil markets – for example, keeping an eye on oversupply issues or lower demand caused by the popularity of alternative energy sources. Political instability or world crisis also play a major part in oil price fluctuations.
- Lastly, understanding the motivations of key crude oil industry playersis paramount. Using the right trading style and strategy is also important.
Finding your crude oil trading style and strategy
The most successful crude oil traders always use the right strategy to suit their trading style, so figure out your style right away. Your trading style will be determined by the amount of purchasing power you have – or can potentially have access to – and your own personal appetite for risk. A long-term trading style will suit people who are interested in lower yet more sustainable profits with less risk. A short-term trading style will be better for those investors who are willing to be exposed to more risk.
Deciding what type of investment style will best suit your personality will make it easier for you and your broker to decide on what trading strategy to adopt.
Because of the volatility of the crude oil market, short term day trading is always a popular trading strategy. Day traders close out at the end of each trading session and can make large profits if they have correctly speculated on the movement of the day’s crude oil prices.
Another strategy is breakout trading. Breakout trading involves buying or selling once the commodity in question has broken through a predetermined price level.
Range trading is also popular and involves buying and selling depending on the levels of support or resistance in the market.
Whatever strategy you choose, risk is always inherent. This is why staying well informed of what is moving the oil markets is crucial.
Setting your stops and limits
It is difficult to overstress the importance of setting the appropriate stops and limits when investing in the crude oil markets. Many people often equate trading in commodities to gambling and while this is not a perfect analogy, there are some common factors. A successful gambler will never bet more than they can afford to lose.
Stops and limit orders are the best methods of limiting your exposure to risk. Stops and limits work when a broker buys or sells a stock once it has reached a set price, thus putting a cap on the amount you may lose if the trade goes against you. Stop orders are invisible to the marketplace, while limit orders can be seen by other traders.
Risks of crude oil trading
Although the crude oil market can hold many profitable opportunities for investors, it is also fraught with risk. The most important point to keep in mind when trading on the crude oil market is that it is an incredibly volatile marketplace. A huge number of factors can influence whether crude oil prices rise or fall. An oil tanker spill or an extreme weather event can severely impact prices, sending them skyrocketing as supply falls. The rise of an alternative fuel source in a major oil-producing nation can quickly cause crude oil prices to drop – the recent advances in solar power technologies are a good example of this. Staying on top of market trends can avoid risk.
Crude Oil Trading – Conclusion
Successfully trading in crude oil by making the right choices on short term futures or ensuring long term profits by investing in oil-producing companies takes a huge amount of skill. We recommend that any new investor works with an experienced and highly reputable broker with a proven track record. Only a broker that has the right experience and an in-depth understanding of what moves oil prices will be able to keep up with the inherent instability of the market.
With the right advice, it is possible to generate healthy profits by investing in the crude oil market. However, without a good understanding of the pitfalls involved, new investors could find themselves unnecessarily exposed to risk.