Guide to Crude Oil Trading – Introduction
Crude Oil is one of the most liquid commodities in the market. According to the CME Group, more than $80 billion worth of oil is traded on a daily basis. This Crude Oil is used to power vehicles and machines around the world. This liquidity has led to increased volatility in the oil futures market as investors use it as a hedging tool. In fact, today, oil is one of the main causes of market movements. In 2015, oil price went down which led to the S&P and Dow to go down. This year, the price has recovered significantly which has led to an upward move in the market. Here are the four key steps you need to follow when you approach the crude oil trading.
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#1 – Understand the Main Movers of Oil Prices
To be successful in crude oil trading, you need to understand what moves it. Of course, being a commodity, oil price is moved by demand and supply. An increase in supply leads to a reduction in price while an increase in demand leads to an increase in price. Now, it’s more complicated than this but the fundamentals remain similar. To understand the supply, you need to know where oil comes from. Essentially, it comes from OPEC and non-OPEC countries. It is consumed (demand) worldwide. Therefore, any happening that threatens oil supply such as conflict will lead to a shortage of oil and thus the reduction in price. For example, a few months ago, a Russian plane was downed by Turkey. Many believed that this would lead to conflict thus pushing the prices up. Here are a few things that will always move the price:
- Oil inventory data. This is released every Wednesday by EIA. An increase in inventory will lead to low prices.
- Comments by key political figures in oil such as Minister of Energy of Saudi Arabia.
- Comments by key oil professionals such as OPEC president.
- A strengthening dollar will lead to reduced prices.
- Economic data. For instance, the strengthening of Chinese economy will lead to increased consumption and thus demand. This will push prices up.
- Geopolitical issues. Conflicts leads to increased prices.
#2 – Understand the Market Sentiment
The factors described above are purely fundamental in nature. The oil market, just like any other market does not work based on the fundamentals. Technical factors play an important role in determining how the oil prices will move. Traders use the technical indicators to determine the market sentiment. For instance, the Relative Strength Index (RSI) is one of the most commonly used tool that determines the oversold or overbought positions. In the last few months, the oversupply concerns have not faded but the market sentiment is that oil price will continue to go up. As a trader, you need to have a good understanding of this.
#3 – Read Books on Oil
As a trader, reading is one thing that you can’t do without. By reading books on crude oil, you will be at a good position to understand the historic background of the commodity. It will also help you understand how the commodity works and how the cycles have moved. There are many books on oil in the market today. Hot Commodities by Jim Rogers is one of the best books on oil (and commodities you can read). Rogers is an expert who founded The Quantum Fund with George Soros. Other books you can read are Trading and Investing in Crude Oil for Beginners by J. R. Calcaterra and Fundamentals of Trading Energy Futures & Options by Steven Errera. These books will give you a historic background on oil and the different cycles it has gone through.
#4 – Develop a Strategy
This step assumes that you have some background in charting and trading. You should now create the strategy you will use to trade. This strategy should be holistic meaning you should combine the fundamental, technical, and sentimental analysis in it. After developing it, you should go ahead and backtest it. One strategy you can pursue is combining the WTI and Brent crude. Brent is the world’s benchmark while WTI is the United States standard. The two ‘oils’ move in the same direction. Therefore, you can buy and sell the two simultaneously with different lot sizes. Your profit will therefore be the difference between the loss and profit.