In the first part of this article, we delved into the differences between Brent and WTI crude oil, the factors that influence oil prices, and the crucial role oil plays in the global economy. Now, let's shift our focus to practical oil trading strategies and tips to equip you with some useful knowledge for commodity trading.
What Is Oil Trading ?
The world runs on oil, and the price of this vital resource fluctuates constantly. This fluctuation creates a market where people can trade oil contracts, aiming to profit from these price movements.
In general, trading involves buying and selling assets like stocks, indices, bonds, currencies, ETF, cryptocurrencies, or commodities (like oil) in the hopes of making a profit. This is done through contracts that represent ownership of the underlying asset, not by physically buying and storing barrels of oil (see next part for more details).
If you believe the price of oil will increase, you can buy oil contracts. Your profit comes from selling these contracts later at a higher price. If, on the other hand, you believe the price of oil will decrease, you can short-sell the commodity.
Short-selling oil contracts is all about "borrowing" oil contracts from your broker to sell them immediately in order to buy them back to "give back" the borrowed ones. If the price has indeed fallen, you can buy back the asset at a lower price and pocket the difference (minus the commissions of ActivTrades).
It’s important to highlight that short selling can be a riskier strategy, as there's theoretically no limit to how high the price could go, leading to potential huge losses. However, short-selling is a good way to profit from falling prices.
7 Ways to Get Exposed to the Oil Markets
There are several ways to gain exposure to the oil market, each with varying levels of risk and involvement:
- Contract For Difference (CFD) on oil
- Oil futures contracts
- Oil options contracts
- Shares of oil companies
- CFDs on oil companies
- Exchange-Traded Funds (ETF) on oil or on energy commodity
- ETF on oil companies
How Can You Analyse the Evolution of Oil Prices?
To decide whether to buy and short-sell oil contracts, traders usually use either technical analysis or fundamental analysis.
Technical analysis focuses on historical price and volume data to identify major price patterns and trends. Technical traders can use a variety of tools like technical indicators (moving averages, relative strength index, bollinger bands, ichimoku cloud, pivot points, etc.), support and resistance levels, channels, trend lines and chart patterns (head-and-shoulder, hanging man, engulfing, wedges, flags, pennants, double tops. etc.) to forecast future price movements.
The most important underlying assumption of technical analysis is that past market behaviour can offer clues about future direction.
While technical analysis doesn't consider the underlying factors driving oil prices and what drives the market dynamic, it is particularly useful for identifying short-term trading opportunities and fine tuning your entry points.
Fundamental analysis takes a broader perspective, focusing on the economic, geopolitical, and supply-demand factors that influence oil prices such as factors we mentioned in the first part of this article, like global economic growth, geopolitical tensions, OPEC’s decisions, inventory levels, and alternative energy sources, among others.
Usually, fundamental analysis provides a deeper understanding of the forces driving the oil market. It can help identify long-term trends and potential turning points that technical analysis might miss. On the other hand, the analysis approach requires ongoing research and monitoring of complex economic and geopolitical factors, which is quite complex and may not always be effective in predicting short-term price movements.
As you might guess, there's no single "right" approach for oil traders. While many successful traders leverage a combination of technical and fundamental analysis, others prefer to only focus on one analysis method and master it.
Which Kind of Indicators Should You Follow When Trading Oil?
Those who trade oil pay close attention to the economic indicators that are associated with the petroleum business, notably the levels of production and the crude oil stockpiles. These inventories, which are announced on a weekly basis by the Energy Information Administration (EIA) at 10:30 AM Eastern Standard Time (EST) every Wednesday, show the quantity of oil that is presently being stored for consumption in the future and reflect the state of balance between oil production and consumption.
To get insight into probable future fluctuations in oil prices, energy traders compare the reported crude inventory statistics to expectations and historical levels. This allows them to better understand the market.
An increase in inventory is indicative of a supply excess, which might result in a decrease in the price of oil. On the other hand, falling stocks are an indication of a tighter supply, which may cause prices to reach higher levels.
As a result of the substantial influence that OPEC meetings have on the global oil market, oil traders also pay careful attention to these conference sessions.
The member nations of OPEC discuss and make decisions on output quotas during these meetings, which are extremely important. Prices are affected as a direct result of these quotas, which have an effect on the worldwide supply of oil.
There is the potential for major price changes to result from decisions to either raise or decrease output. In most cases, their judgements also contribute to the management of supply-demand balances, which is an essential component of market stability.
In addition to following live coverage of OPEC meetings, oil traders may also look to official statements and news releases that outline the choices that were taken in order to have a better understanding of the particulars of output adjustments and policy changes.
It is also important for traders to take into account larger economic statistics and estimates that are addressed during OPEC meetings. These include forecasts of global demand, rates of economic growth, and inventory levels.
Trading Strategies Can You Use to Trade Oil Markets
Technical traders in the oil market can use news events to spot short-term trading opportunities. This is a trading strategy called news trading.
News can indeed have a significant impact on price movements, often coinciding with existing technical signals.
For example, if a support level is identified on the chart and news emerges about an unforeseen production cut by a significant OPEC member, it could potentially reinforce the support level and present a favourable opportunity for purchasing.
As mentioned earlier, the weekly releases from the EIA on U.S. crude oil inventories and OPEC meetings are highly anticipated events.
It’s also important for traders to stay updated on current events, as any conflicts, sanctions, or political instability in major oil-producing regions can have a significant impact on supply and cause prices to skyrocket. On the other hand, if there is any positive development in diplomacy or a resolution to a conflict, this could result in a decrease in prices.
Factors such as GDP data, consumer spending figures, and manufacturing activity reports can have an impact on oil demand as well.
With strong economic growth, there is a possibility of increased oil demand, leading to potential price hikes. On the other hand, when economic data is not strong, it indicates a decrease in demand, which could result in lower prices.
It is possible for traders to engage in trend trading if they want to profit from potentially relatively large price swings.
In this type of trading, it is essential to have a solid understanding of the overall direction in which the price of oil is moving and to capitalise on the trend that is now occurring.
The validation of the trend and the execution of proper buy or sell orders are usually both dependent on the use of technical indicators, which can include moving averages and trendlines.
Oil Trading Tips
Take time to understand the underlying factors pushing oil prices up or down.
Decide how to invest in oil in accordance with your risk tolerance, your trader profile, your goal and your time horizon.
Create a detailed trading plan.
Do not underestimate money and risk management rules to better protect your capital (remember that oil prices can be volatile and that financial products like CFD are risky and complex).
Always keep an eye on key indicators that can influence the price of oil.
Before risking real money in oil trading, practice trading with simulated markets to understand how prices react to different scenarios with a demo account. Additionally, a demo account can help you discover your broker’s platform and its trading features.
Begin with small investments to limit potential losses while you gain experience.
Always keep learning about oil trading techniques and strategies to constantly improve your trading.
Regularly review your trading performance and adapt your strategy based on what you learn.
The information provided does not constitute investment research. The material has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and as such is to be considered to be a marketing communication.
All information has been prepared by ActivTrades (“AT”). The information does not contain a record of AT’s prices, or an offer of or solicitation for a transaction in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information.
Any material provided does not have regard to the specific investment objective and financial situation of any person who may receive it. Past performance is not a reliable indicator of future performance. AT provides an execution-only service. Consequently, any person acting on the information provided does so at their own risk.