Oil Trading: The Complete Handbook for Serious Investors
As the main energy source worldwide, oil has a unique standing in global trade, economics and politics. The drilled raw material accounts for about 3% of the world economy and changes in international relations, finance, or the energy sector can cause major fluctuations in its market value. These moves offer major opportunities for gains. However, traders often fail to make the most of the intense price action, either because they are not familiar with the market’s unique features or because they fall into common pitfalls.
To ensure you have what you need to succeed, we are delving into the basics of oil trading, study what moves the price of “black gold”, introduce the fundamentals of effective strategies and investigate what the future could look like for the sector – all within this comprehensive oil trading guide suitable for traders of any level.
What is Oil Trading?
Oil trading involves the buying or selling of different kinds of oil. Market participants seek to generate profits from the transactions, which can either involve exchanging the raw material or speculating on its price. Oil is a widely used, non-renewable resource with limited availability, showcasing heightened sensitivity to shifts in geopolitics, supply and demand. Therefore, prices can fluctuate widely; and it is this heightened volatility that makes the asset popular among investors.
What Oil Markets can you Trade?
There are hundreds of crude oil varieties traded and used globally, but only two primary oil markets, Brent Crude and West Texas Intermediate Crude (WTI). These specific varieties are what is referred to as “oil markets” in global headlines and news reports. They are used as benchmarks against which the prices of other more independently produced types of oil are set – which helps standardize the market. It is important that you understand the differences between these two oil benchmarks before you position yourself on any of them.
West Texas Intermediate (WTI) – It is produced in North America and primarily extracted from oil fields in Texas. It is used as a benchmark for global oil prices. Its futures are traded on the New York Mercantile Exchange (NYMEX), and its price is highly sensitive to changes in domestic supply and demand.
Brent Crude – It is extracted from oil fields in the North Sea, and its futures are traded on the Intercontinental Exchange (ICE). It is the main benchmark for oil prices across Africa, Europe and the Middle East, areas responsible for around two thirds of global oil production. The price for Brent crude oil is highly responsive to changes in global markets and the geopolitical situation in Europe and the Middle East.
How do I Invest in Crude Oil?
Investing in oil and benefiting from price shifts in the highly volatile assets can be achieved through various financial vehicles. At Windsor Brokers, we offer speculative traders and investors the opportunity to position themselves in the Brent Crude and West Texas Intermediate oil markets through CFDs.
Why Trade Oil Using CFDs?
Contracts for Difference (CFDs) allow you to speculate on the price movement of the asset, and profit both from rising and falling markets. When trading CFDs, you “buy” or “sell” oil without the need to own the actual number of barrels you are exchanging. At the same time, you can use leverage to open larger positions with significantly less capital than you would normally need.
CFD Futures on Oil
Futures contracts are agreements to trade, either buy or sell, an asset at a predefined price on a predefined date in the future. These types of contracts are mainly traded on exchanges and involve conditions and set expiration dates.
However, when you trade CFD futures on oil, you are using a product that reflects the price of the futures contract but does not restrict you to an expiry date. You open a short or long position, expecting the price of oil to either fall or increase by the time the agreement expires. However, you are free to close the trade at any time, even before the contract’s expiration date. If you choose not to, the position automatically closes at whatever price is available, at the predetermined closing time. CFD futures offer flexibility and can be suitable for long-term strategies or hedging purposes.
CFDs on Oil Spot Prices
Spot prices reflect the cost of buying or selling an asset in real time. Therefore, trading CFDs on the spot price of oil means you are speculating whether the current price of Brent Crude or WTI will move up or down. This specific investment vehicle fits short-term strategies.
CFDs on Oil Stocks
You can gain indirect exposure to the oil markets, by trading the shares of companies focusing on the exploration, extraction, refinement and distribution of crude oil. This type of investment provides opportunities based not only on the price of the commodity but also on company-related factors like financial performance, management and technological innovation. Some of the biggest names in the energy sector include Exxon Mobil, Chevron, Devon Energy and Occidental Petroleum Corporation.
CFDs on Oil ETFs
Exchange-Traded Funds (ETFs) offer an alternative route to the energy sector. By allowing you to invest in a basket of oil-related securities including stocks, futures or options, they offer broader exposure to the commodity market through a single position. And, with CFDs on energy ETFs, you can capitalize on the rise or fall of the entire oil industry.
What Moves the Price of Oil
Oil is one of the most volatile commodities in the world, as prices often experience rapid movement in response to economic, geopolitical and technology-related shifts. You can decode the complexities of this dynamic trading environment when you familiarize yourself with the asset’s primary market movers:
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Supply and Demand
Oil is no exception to the supply and demand dynamics which shape commodity prices. The general rule is; increased supply causes a drop in prices, while high demand drives prices higher. In contrast, reduced supply leads to a price increase, while a decline in demand causes prices to lower. Oil supply levels are determined by major producers, including OPEC, the USA and Canada, and their decision to boost or cut down production. Conversely, oil demand can be affected by factors like global economic performance and the advancement of clean energy sources.
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Geopolitical Events
Unrest and conflict in oil-producing regions as well as strategic decisions by countries or groups responsible for global oil distribution, can cause uncertainty for future supply levels. The risk of oil infrastructure being hit, port and oil maritime passages remaining closed can push prices upwards.
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Global Economic Performance
Key economic metrics, like GDP, retail sales, consumer spending, industrial production and employment figures gauge the health of the global economy and shape central bank interest rates; put in place to either boost or slow down financial activity. In periods of economic growth, oil demand can rise, pushing prices higher. In contrast, during an economic slowdown, oil demand as well as prices can go down.
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Trade Policies
The announcement of trade agreements, embargoes, tariffs or sanctions reveals either strengthened or strained relationships among nations and can impact oil prices. Good international relations can enhance oil trade and ensure consistent supply, while tensions can affect availability or oil shipping routes, leading to lower supply and higher prices.
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Market Sentiment
Market sentiment reflects investor attitude in the markets and is heavily influenced by crowd psychology. Optimistic or bullish market sentiment can boost buying and push oil prices upwards, while bearish or pessimistic market sentiment can trigger selling, leading to lower prices.
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Technological Innovation
Improvements in the machinery, tools and methods used for the extraction, refinement and delivery of crude oil can cause an uptick in the supply and downward pressure on prices. For instance, advancements in fracking techniques, used to retrieve oil from the ground, are helping increase the commodity supply.
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Green Energy Advancements
Global clean energy initiatives and environmental laws are pushing for the development and widespread implementation of power generation methods with lower environmental impact. Progress in alternative energy sources harnessing the potential of the wind, sun or water can shape long-term demand projections for oil, influence investor sentiment and affect prices.
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Oil Storage
Any oil surplus, the result of continued production but dwindling demand, is kept in storage facilities. However, these tanks can only hold a certain amount of the raw material and as they fill up, investor concern levels can rise, causing price drops. For example, in April 2020, at the height of the coronavirus global shutdown, increasing stockpiles were dangerously close to overwhelming storage. This led to a dramatic fall in oil futures and the commodity briefly trading at negative prices for the first time.
How OPEC is Shaping Oil Trading
OPEC, a name all oil traders should be familiar with, stands for Organization of the Petroleum Exporting Countries. OPEC is a cartel including the biggest oil-producing countries in the world. In 2016, OPEC+ was also created, forming a powerful alliance between OPEC members and other oil-exporting nations.
The main purpose of this entity is to set the global price for oil by adjusting its supply. As OPEC controls over 40% of global oil supplies and more than 80% of oil reserves, they can exert significant influence on the commodity’s market value. However, the effect is often felt in the short term, as individual member countries may have different goals than OPEC as a whole.
The energy cartel accomplishes its strategic objectives by setting production quotas for all member nations. When availability is limited, their profits increase. But, when there is an oil glut, they ensure their competitors cannot undermine their power. OPEC showed the extend of its dominance in 1973, when they embargoed oil exports to the US. This caused global oil prices to increase by nearly four times and drove the global economy into a recession.
The Inverse Relationship Between Oil and the US Dollar
Oil, the most important global natural resource, and the US dollar, the world’s primary global reserve currency, move counter to one another. When the dollar appreciates, the price of oil drops and alternatively, when the currency weakens, the price of the commodity increases.
This relationship is partly attributed to the “petrodollar” system, an informal global agreement according to which oil-related transactions worldwide are primarily executed in US dollars. If the dollar strengthens, crude becomes more expensive for non-US buyers, leading to lower demand. In contrast, when the dollar depreciates, oil becomes comparatively more affordable for those international buyers, which drives demand and prices higher.
The Hidden Oil Price Movers Most Traders Miss
Beyond the broadly talked-about economic, political, and technological variables that can drive global oil prices up or down, there are some lesser-known factors that seasoned traders take into account before making trading decisions and entering positions in Brent Crude or WTI.
Weather Conditions
Hurricanes, tropical storms, extreme cold or heat can reduce operating capacity or completely halt operations at oil rigs, due to heavy rain, winds, freeze-offs, electrical strain or mechanical shutdowns. Depending on the duration of the adverse weather conditions, oil production and delivery could be significantly disrupted, leading to strained supply and higher prices.
Seasonal Demand
Oil prices tend to follow seasonal patterns. For example, during winter, they often climb higher as demand for heating oils, which are crude-based derivatives, increases. However unusually mild winters can cause reduced demand. Also, the summer vacation season can put upward pressure on prices as people drive more for travelling purposes.
Institutional Moves
When hedge funds or big asset managers buy or sell at large volumes, in the futures or derivatives markets, speculation around oil and underlying trends strengthen. This can cause oil prices to significantly swing even if supply and demand fundamentals cannot justify the movements.
Historical Price Action: How Fundamentals Shaped Oil Prices in the Past
We have already talked about the factors that can drive oil prices up or down. Also studying how they have played out before, through real life examples, can help you gain a more realistic grasp of their effects and enable you to spot future opportunities more easily.
1990-1991 Gulf War
Iraq invaded Kuwait in 1990, triggering investor concern over disrupted supply during the conflict. The regional hostilities and geopolitical uncertainty caused global oil prices to soar by more than 100%.
2008 Financial Crisis
In 2008, a global recession hit financial markets, prompting reduced economic growth. This led to a dramatic decrease in oil demand and escalated into a steep price decline. More specifically, after hitting highs of about $140 per barrel in 2008, prices sank to below $40 by the end of the same year.
2020 Oil Price Collapse
During the 2020 coronavirus global shutdown, oil markets saw an unprecedented scenario unfold; oil prices briefly plummeted to below $0 per barrel. As people had to be confined indoors to avoid contamination, worries around the tightening oil-storage capacity and the oil glut caused a never-before-seen crash.
The Essentials for Every Oil Trading Strategy
Oil markets are as known for their volatility as for their lucrative investment opportunities. Therefore, for those of you looking to dive into oil trading, a comprehensive trading strategy is more than a choice, it is a necessity. And beyond technical and fundamental analysis to help you identify setups with precision, it should also include a solid risk management plan to ensure the long-term protection of your capital against price fluctuations. Here is our list of essentials for any WTI or Brent Crude trading strategy:
Technical indicators – Trading indicators like Moving Averages, RSI, MACD can help you spot trends, assess volatility, measure momentum, analyze volume or identify support and resistance levels.
Chart patterns identification – Learning how to spot both simple and complex chart formations enables you to identify whether prices could be turning or continuing in the same direction.
Volume and volatility analysis – Tracking trading volume allows you to verify trends, detect breakouts and reversals and recognize institutional activity. At the same time, monitoring volatility levels enables you to assess price risk, place informed stop-loss orders and identify market cycles.
Advanced trading tools – Cutting-edge tools like Trading Central can simplify the trading process and help you catch market opportunities fast; with trade ideas, expert analysis, news and sentiment analysis and real-time insights on WTI and Brent Crude products, as well as hundreds of other assets.
Following market updates – Staying up to date with the latest market trends, news, world events, economic releases, technological updates, weather conditions, is imperative. Make sure you follow anything that can trigger price movement in the oil markets.
Diversification – By spreading investments across a diverse set of assets, showing zero or inverse correlations, you mitigate the risk of the markets moving against all your positions, at the same time, and ultimately avoid an account drawdown.
Stop-loss orders – Predefining your loss limit and setting an automatically triggered order at that level, ensures you do not risk more than you can afford to.
Position sizing – Assigning only part of your capital on oil trades protects your portfolio from big losses, helps preserve your capital in the long term, and allows for consistent growth over multiple reasonably sized trades.
Leverage management – Using leverage with caution is important, as it can increase your gains by the same factor that it can amplify your losses.
What Could the Future of Oil Trading Look Like?
The future of oil markets depends on the global shift to renewable energy sources including solar, wind and hydroelectric power. Currently, oil maintains its dominance in the energy sector. This is because the cost of switching to greener solutions remains high and despite environmental concerns and political pressure, the process has been slow.
However, even when the transition reaches completion, crude oil will most probably not lose its relevance, entirely. The raw material is a key ingredient for the production of plastic products, which are still in demand both within the consumer and manufacturing sectors.
Simultaneously, the use of AI across the industry can drastically optimize oil detection, drilling operations, system diagnostics, refinery processes and supply chains, causing a significant drop in prices. This would enhance the competitiveness of oil, making it even more difficult to replace as a primary source of energy, at least in the short term.
Future Projections for Oil Markets
In the long term, renewable energy is expected to become more cost-efficient and widely adopted, causing a decline in oil demand. During the transitional phase, oil markets are likely to maintain their volatility, as prices could showcase stronger responsiveness to geopolitical events and economic factors. However, as the “green” shift concludes and reliance on oil declines, the effect of geopolitical factors could diminish over time.
Trading oil CFDs during this major change in market dynamics could present ample opportunities for gains. And let’s not forget, oil is expected to maintain a presence in industrial production and global markets, even if weakened compared to its current dominant status. At the same time, investing in the shares of renewable energy companies like Sunrun and Enphase opens up possibilities for capitalizing on the rise of these newer technologies.
Overview
To trade oil and generate consistent gains, you need to develop a deep understanding of the market’s inner workings. That includes learning the differences between Brent crude and WTI, what financial vehicles allow you to make the most of price action, what moves the prices of the commodity, how to develop powerful strategies and what future projections show. With this complete handbook you can navigate the complexities of this highly volatile market, currently in a transitionary state, with confidence. And, by opening your Windsor Brokers trading account, you can make the most of the lucrative opportunities with some of the best trading conditions industry wide.