How to trade oil?

Crude oil is unrefined petroleum and one of fossil fuels. It is made up of deposits of hydrocarbons and other organic materials and can be processed to produce useful products such as gasoline, diesel fuel, petrochemicals (such as plastics), fertilizers, and even medicines.

Oil is the main and most important component of the global economy and has a great impact on our daily lives, so it is closely monitored by economists, businessmen and traders. In this guide, we will find out how the price of crude oil affects the stock market and ways to trade it.

What is oil trading?

Oil is one of the largest trading commodities because of its volatility and liquidity. It’s traded on various markets and allows for different forms of investment. Thanks to ever-changing supply and demand, it makes up for a great trading opportunity. At the same time, it poses risks to investors.

There’s a multitude of instruments and platforms available for oil trading. In this guide, we will review them in detail.

Ways to Trade Crude Oil

There are several ways of trading crude oil: spot trading, futures, options, ETFs and stocks. We will review them in detail below.

Oil Futures

Futures are contracts proving that you want to sell a fixed volume of oil at a certain price on a pre-set date. They are offered on exchanges and reflect demand on oil. This is a widespread method of oil trading that enables traders to earn on price fluctuations.

Futures are usually exploited by companies that want to ensure a certain price for oil and hedge their risks regardless of value fluctuations. At the same time, speculative traders trade on them, too - they only need to fulfill contracts. There’s no need to care about oil delivery and other operational tasks.

Futures are present for both types of oil: Brent Crude is traded on the Intercontinental Exchange (ICE), while West Texas Intermediate (WTI) - on the New York Mercantile Exchange (NYMEX). They serve as the standards of crude oil prices around the world and as indicators of the economic situation.

Oil Options

Options are pretty much the same thing as futures contracts, but there’s no fixed date for trading - you can sell them before or after the set expiry moment.

Options are divided into two types: puts and calls. If you predict that the crude oil price will rise, you can purchase a call option, if you think it will fall - purchase a put. For taking the opposed deals, you can sell options. Selling options are a nice way of generating income during a quiet market because you’re receiving income outside your trade. However, you should always track the market and try to mitigate risks.

Oil ETFs

Exchange-traded funds (ETFs) are a great ready-made solution for investors and traders. Some of them are leveraged in two ways:

• Standard leverage. It multiplies the income from an index.
• Inverse leverage. It multiplies the opposite of a performance index. For example, with inverse leverage of x3, a 2% fall in the market will result in a 6% gain.

Shares of oil companies

This is the simplest way of trading crude oil because you can buy shares of oil companies that you believe will perform well and sell them whenever you want. As a rule, there is a direct correlation between crude oil prices and the value of companies’ stocks. At the same time, outside factors like pandemics and economic crises may greatly affect the cost of shares.

Oil CFDs

Contracts for difference (CFDs) is a financial derivative that allows traders to open a position depending on what they bet on - market fall or rise. The major difference between spread betting and CFDs is tax obligations. Spread bets are free from capital gains tax, while profits from CFDs can be offset against losses for tax purposes.

Earning on CFDs is possible in the following ways:

• Buy oil and sell it at a higher price (a long position).
• Trade oil CFDs, i.e. sell at a high price and then buy at a lower price (a short position).
• Traders can use various forms of wave, technical and fundamental analysis to increase their chances of success by choosing the right tool, which requires adequate knowledge, experience and training. Nevertheless, the CFD trader shall always be aware of the risky nature of this derivative…

Advantages and disadvantages of oil trading

If you consider trading oil, weigh all pros and cons of this commodity:

Oil trading hours

The majority of oil trading markets are running 24/7. However, you should be aware of trading breaks and opening/closing hours for each market. It is important for making timely deals.

Oil trading from Monday to Friday is organized during the following hours:

Tips for Trading in the Oil Market

You should mind a few peculiarities of oil price formation:

1. Higher crude oil prices tend to increase the cost of petroleum products, which in turn undermines economic growth as it creates the potential for inflation and higher interest rates.
2. Lower crude oil prices tend to make food more affordable, which in turn stimulates economic growth as it reduces the likelihood of inflation and rising interest rates.
3. Very low prices could reduce supply as producers cut their current production or put new oil projects on hold.
4. Oil prices change and fluctuate daily and every minute and are influenced by a wide range of factors.
5. Use technical indicators to analyze the market efficiently. For instance, Fibonacci arcs display the difference between price highs and lows during a certain period.
6. Don’t forget that Brent and WTI are not the same thing and can react to global events and news with a different degree of price fluctuations.
7. Study trading psychology. It will save you from panic selling and will give you better control over potential market movements.
8. Keep tabs on supply and demand metrics. Major economic media always provide timely data.
9. High liquidity is your friend and fiend. Although it provides a lot of space for price speculation, it comes with a high risk.

Brent vs. WTI Crude Oil

Brent North Sea Crude oil, commonly known as Brent Crude, refers to oil produced from the Brent fields and other locations in the North Sea. Brent oil futures are traded on the Intercontinental Exchange (ICE).

The price of Brent affects the cost of about two-thirds of the world’s crude oil production as it is used as a benchmark for African, European and Middle Eastern crude oil. Delivery locations for Brent futures vary by country as Brent is traded all over the world.

West Texas Intermediate oil, commonly known as WTI, is a mixture of several US domestic crude oils. WTI futures are traded on the NYMEX (New York Mercantile Exchange), a division of the CME (Chicago Mercantile Exchange). The WTI benchmark is used by several Asian countries, along with Brent, to value their own crude oil. The WTI delivery point is located in Cushing, Oklahoma.

Note that Brent determines the price of approximately 70% of all grades of oil that are exported from around the world, initially tied to the grade of the same name, which was produced in the British sector of the North Sea. WTI is the main marker variety for the USA, which for a long time was the only one in the world.

The cost of oil is a variable that depends on a huge number of parameters: quality characteristics, delivery conditions, demand, the state of the largest economies in the world.

What factors affect the price of oil?

There’s a large list of factors that impact the cost of oil. The most widespread ones include:

• Increase or decrease in supply from oil producers.
• Increase or decrease in demand from oil users and importers.
• Subsidies for oil companies or other energy companies.
• International politics (agreements between countries).
• Domestic policy of the oil producer country.
• World oil supplies.
• Competition from other energy sources.
• Geopolitical tensions and insecurity (tends to increase prices).
• Announcements and regulations by OPEC.
• Development of alternative energy sources.

Let’s review some of these factors more closely.

Global oil supply

Oil is produced in 100 countries, that is, in about half of the world. Five of these countries produce 48% of the world’s crude oil production. That gives these oil-producing countries and oil associations (such as OPEC) more control over their supply and price.

They can reduce oil production to stop prices from falling or help raise them. And they can also increase oil production if they think that the price is high enough to sell it and make a profit.

A nice example is the price war between Russia and Saudi Arabia. Given Russia’s refusal to cut production to boost the price of oil, Saudi Arabia decided to lower the price per barrel and thus regain market share. This caused an even greater drop in oil prices.

State of the global economy

Demand for oil rises when the global economy is doing well because consumers buy more products (where oil is often used to create goods), companies ship and transport more goods (due to higher demand), companies invest more (to build enough capacity), and overall oil consumption rises.

The weakening of the world economy has the opposite effect and reduces the demand for oil. As a result, prices fluctuate.

Seasonality

During hot summer days, oil consumption is higher because of overall increased activity. On cold winter days, people need more oil products to heat their dwellings.

Conclusion

Being the most commonly traded commodity, oil is a great instrument to study the market for both seasoned investors and beginners. They can benefit from a bunch of tools and platforms offering this asset. However, earning possibilities come with a high risk.

Before you opt for a CFD, option, share or future, make sure to study the market and find ways to get relevant information. It’s important to keep your finger at the pulse and learn to predict oil price movements according to what’s happening around.