Crude oil is one of the most important commodities critical to the global economy. After being transformed into petroleum it is used to power automobiles, planes and other vehicles in addition to being a key energy source used in heating, asphalt, and electricity.
Besides its use in energy, petroleum is used to manufacture plastic goods and household items like detergents and paint. For these reasons, investing in crude oil gives many investors opportunities to profit in almost all market conditions due to its importance to the world economy.
The price of oil is generally referred to as the spot price of a barrel of benchmark crude oil. It is commonly referenced according to the sellers of crude oil such as West Texas Intermediate (WTI), Brent Crude, Western Canadian Select (WCS), Urals oil, OPEC Reference Basket, Tapis crude, Bonny Light, Dubai Crude and Isthmus. The spot prices are different for each type due to the processing required to transform each into petroleum.
Check the WTI price chart on Mitrade
OPEC is an intergovernmental organization of 13 oil-producing countries that was founded in Baghdad in 1960, with headquarters in Vienna, Austria. The purpose of the organization is to collaborate oil production in order to create price stability and reduce competition. Following the activities of OPEC is crucial to understanding how the price of oil moves.
As of September 2018, OPEC nations account for an estimated 81.5 percent of the world’s oil reserves and 44 percent of global oil production, according to this Wikipedia page that links to other sources that compile statistics from OPEC and the U.S. Energy Information Administration. This large market share highly influences how oil price moves, making OPEC a prominent player in the global industry.
Since the dawn of the oil age in the mid-19th century, the price of oil remained relatively steady until the 1970s, when various world events embedded in war, conflict and political tyranny led to price shocks and drops until the present day.
The 2020 Russia–Saudi Arabia Oil Price War
Events associated with the coronavirus “pandemic” led to government lockdowns in 2020 that substantially decreased economic activity, leading to price drops made worse by the 2020 Russia–Saudi Arabia oil price war.
The price war was triggered in March 2020 by Saudi Arabia in response to Russia's refusal to reduce the production of oil. The desire for this is associated with market factors that increase oil price when production (and therefore inventory) decrease, resulting in a higher overall price.
This event created a flood of product on the market, resulting in sharply falling prices that went negative on April 20. This condition is characterized by supply amounts so high in comparison to demand that producers must pay to have it removed from the site.
As of this writing, the economy is still in a depression however there are some optimistic estimates with respect to oil prices for the coming year. According to some forecasts, Brent crude oil prices for 2020 will rise to approximately $33 per barrel, rising further to about $45 per barrel in 2021 according to the estimates.
The International Monetary Fund’s latest World Economic Outlook release predicts a slightly higher Brent Crude price of approximately $37 per barrel in 2020 with a further increase to about $40 in 2021.
These predictions are prompting many people to consider investing in oil, however opinions vary widely among analysts with different outlooks in the short, medium and long-term with respect to price.
Investors wishing to leverage the volatile price markets for crude oil have several options as follows:
1. Oil Stock Investment
Oil exploration companies are directly affected by the spot price of oil, making them a popular way to indirectly invest in the market. This is a common way for traders to gain exposure to the market, giving them options for profiting on the value appreciation of the shares and the dividends paid.
It is important to take note prior to investing in companies that the market for renewables and other fuels is always evolving and that hydro-carbon based energy is gradually being phased out.
2. Oil Futures
As mentioned earlier in the article, there are several crude oil benchmarks for the spot price of oil. Two of the most popular ones for oil trading are WTI and Brent crude, and can be traded through futures contracts.
Futures are contracts that require the buyer and purchaser to trade an asset at a predetermined contract date at a specific price.
Performed on special commodities exchanges, WTI futures can be traded on the New York Mercantile Exchange (NYMEX) and Brent futures can be traded on the Intercontinental Exchange (ICE) in London.
3. Oil Exchange-Traded Funds (ETFs)
ETFs are investment instruments traded on stock exchanges that hold assets such as stocks, commodities (like oil), or bonds. This is often the least risky way to invest in crude oil, making it a very popular option for less-experienced traders.
Oil ETFs can be diverse, consisting of the stocks of oil companies and futures into a single instrument. These are often traded similarly to stocks, minimizing the risks of investing in highly volatile oil markets.
4. Master Limited Partnerships (MLPs)
Large-scale investors can invest in crude oil by buying into an MLP. This makes them a limited partner that is entitled to a share of the profits, however does not entitle them to any voting rights.
MLPs are typically associated with the storage and transportation aspects of the oil industry, making their performance different from traditional stocks in the energy sector.
5. Oil Contracts for Difference (CFDs)
CFDs are specialized financial derivative products that allow speculators to trade on the price difference of an asset without owning the asset. Specifically, they are contracts between buyers and sellers where either party profits on the price difference at the end of the contract.
CFDs resemble futures, with a few key differences:
● They are sold on a one-to-one basis with the underlying financial instrument
● CFDs have no expiry date
● CFD investors can buy small contracts as low as one share or unit of the underlying financial instrument
● CFDs can be easily created and are available for a wide variety of investment instruments, like cryptocurrency
● CFD trading is conducted over-the-counter with CFD brokers
● CFDs are not available to US residents
Oil CFDs are ideal for traders that wish to speculate on the price of oil without owning any real assets, have limited funds and wish to use leverage. They offer a straightforward way to make short-term investments based on predictions of the oil market's direction.
How to Use CFDs to Trade Crude Oil ?
Like futures, Crude oil CFDs are generally available as two main products: the US WTI/Light Crude (traded on the New York Exchange) or the Brent crude that is traded on the Intercontinental Exchange (ICE). These are offered over-the-counter through licensed online brokers.
Short vs. Long Oil CFD trading
Trading in Oil CFDs allows traders to speculate on price movements in both directions, going either “long” or “short” depending on predictions for where the price is headed.
Specifically, a trader thinking the price will fall would “go short” on oil and “go long” if they feel the price will rise. The profits or losses for either trade are realized after the position is closed.
Oil CFD Leveraged Trading
Leveraged trading uses credit from the broker to conduct large trades without paying the full cost. While this gives traders the opportunity to make very large trades (and profits) it also magnifies potential losses if the price goes the other way.
CFDs are also used to serve the purpose of hedging the risk exposure in the underlying asset, allowing investors better manage their overall risk.
The following are some trading strategies that some traders use when attempting to profit in the crude oil markets:
1. Understand Crude Oil Price Movements
The price of crude oil moves through supply and demand perceptions in addition to being affected by worldwide production and general global economic prosperity. The general rule is that oversupply and lowered demand encourages traders to sell while rising demand and declining or flat production prompt traders to bid crude oil to higher prices.
2. Understand Investment Sentiment
The energy futures and CFD markets are dominated by many key players such as professional traders that speculate on prices, industry players that take positions to offset physical exposure to other investment instruments and hedge funds that speculate on both long and short-term price fluctuations.
Understanding the motivations behind the activities of all these groups allow traders to speculate on price directions.
3. Choosing Between Brent and WTI Crude Oil
While there are many price indexes, West Texas Intermediate Crude and Brent Crude are the two dominant price indicators. Generally speaking, Brent has become a better indicator of worldwide pricing in recent years, despite WTI being more heavily traded in 2017 in the world futures markets.
Pricing between Brent and WTI tended to stay within a narrow band for years until 2010 with the rise of U.S. oil production (driven primarily by fracking and shale) that increased the output of WTI while Brent drilling decreased substantially.
Another huge factor is the lifting of a U.S. law that prohibited local oil companies from selling to overseas markets. Originally created in the 1970s as a result of the Arab oil embargo, the ban was removed in 2015.
These events are critical in understanding the price differentials between the various benchmarks of oil, and crucial to investment decisions faced by traders in the markets.
4. Use Fundamental and Technical Analysis
Fundamental analysis is the assessment of supply and demand affecting the price of oil. Technical analysis is the identification of buy or sell signals that traders can implement in their trading strategies.
There are several technical indicators and patterns in prices that traders can use as market entry signals, such as Relative Strength Index (RSI) - a main technical indicator used to look for a buy signal. These types of indicators vary in availability, depending on the platform being used.
5. Use Stop Loss Techniques
Stop-Loss techniques are orders placed on the trading interface that allows a trader to exit a trade once the price reaches a specific point. Often used as insurance against losses, stop-losses are an important part of a trader’s strategy in order to avoid depletion of their capital.
Trailing Stop Loss
A trailing stop is a specific stop-loss order that uses both risk management and trade management elements, helping to lock in profits on trades while simultaneously putting a cap on losses if the trade moves unfavourably.
Placed in the same manner as a regular stop-loss order, the main difference is that the trailing stop moves simultaneously as the price moves. Trailing stop loss capabilities are widely available on most platforms or can be implemented manually by the trader.
6. Use the Economic Calendar
Real-time Economic Calendars offer information that cover financial events and global indicators. While not meant to be an overall trading guide, these calendars provide general information on events important to most traders.
CFDs are highly complex and can be very risky when used with a high amount of leverage. This makes them ideally suited to experienced traders and investors. While CFDs are highly lucrative, providing opportunities to make large profits, the losses can be just as high for inexperienced traders.
The complexity of CFDs leave no room for trading errors or misunderstandings. When combined with the use of leverage, many traders can lose more than their initial capital, and inexperienced traders are advised to practice with a demo account prior to using their own money.
Despite the risks, CFDs remain very popular. Low barriers to entry and volatile market conditions continue to offer potential profits, and all traders must exercise caution and research each trade thoroughly prior to execution.
Discover Trading Possibilities With Market Volatility
The content presented above, whether from a third party or not, is considered as general advice only. This article does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Mitrade does not represent that the information provided here is accurate, current or complete. Mitrade is not a financial advisor and all services are provided on an execution only basis. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.