What is oil?
Oil is a highly valued commodity that is crucial for many industries worldwide. As a non-renewable energy resource, oil comes in different forms, such as crude oil, which is extracted from the ground, and refined oil products like gasoline, diesel, and jet fuel. The price of oil is influenced by factors such as supply and demand, geopolitical events, and economic conditions.
What is crude oil?
The main type of oil traded in markets is crude oil, a naturally occurring, unrefined petroleum product that is extracted from the earth. The makeup of crude oil can vary significantly depending on its source, which means there are different types or “grades” of crude oil. Here are some of the major types of crude oil:
- Brent Crude: Brent crude oil is one of the most widely traded and benchmarked types of crude oil. It is primarily composed of a blend of oil from multiple oil fields in the region and is extracted from oil fields in the North Sea, which makes it convenient to transport via tanker. Brent crude is known for its relatively low sulphur content and high American Petroleum Institute (API) gravity, a measure of how heavy or light a petroleum liquid is compared to water. This makes it a "light" and "sweet" crude oil. It is commonly used as a reference price for global oil trading.
- West Texas Intermediate (WTI): WTI is another popular benchmark crude oil. It is extracted from the United States, primarily from oil fields in Texas and surrounding areas. As these oil fields are landlocked, transporting WTI oil is relatively expensive compared to Brent. WTI crude oil is considered a light and sweet crude, like Brent. It is known for its high API gravity and low sulphur content. WTI is traded on the New York Mercantile Exchange (NYMEX) and serves as a pricing reference for crude oil in North America.
- Dubai Crude: Dubai crude is a medium-grade crude oil primarily produced in the Middle East. It is a benchmark for oil pricing in the Asian market. Dubai crude has a higher sulphur content and a lower API gravity compared to Brent and WTI. It is often used as a reference for pricing Middle Eastern and Asian crude oil grades.
- Louisiana Light Sweet (LLS): LLS is a type of crude oil produced in the Gulf of Mexico region of the United States. It is a light and sweet crude, like Brent and WTI. LLS is commonly used as a benchmark for pricing U.S. Gulf Coast-produced crude oil.
- OPEC Basket: The Organization of the Petroleum Exporting Countries (OPEC) calculates an average price for a basket of crude oils produced by its member countries. This basket includes various crude oil grades from countries like Saudi Arabia, Iran, Iraq, Kuwait, and Venezuela. The OPEC basket serves as a reference for pricing OPEC-produced crude oil.
- Canadian Crude: Canada is a significant producer of crude oil, and different types of crude are extracted from its oil sands and conventional oil reserves. The types of Canadian crude include Western Canadian Select (WCS), Syncrude, and Cold Lake Blend. Canadian crude oils are generally heavy and contain higher levels of sulphur compared to light, sweet crude oils like Brent and WTI.
What is the oil market?
The oil market refers to the global network of buyers and sellers involved in the production, refining, distribution, and consumption of oil. It is a complex and highly influential market that significantly impacts the global economy. Major oil-producing countries, oil companies, traders, and consumers are all active participants in this market. The oil market is known for its volatility due to factors like political tensions, natural disasters, decisions made by governing bodies (such as OPEC), and changes in global demand.
What affects oil prices?
There are many factors that influence the price of oil. As a rule, it’s important for anyone trading oil to stay up to date with economic news and market trends to ensure a greater understanding of how prices are affected. Here are some of the main factors affecting oil prices:
- State of the economy: When an economy is performing badly, there is less need for oil, so the price drops. As an economy improves, oil demand recovers, and prices increase.
- Strength of the US dollar: Oil is pegged to and exchanged in US dollars, meaning the value of the USD has a major impact on oil prices; a strengthening dollar can lower prices, and a weak dollar sees them rise.
- Market speculation: Oil prices are set on the futures market, meaning speculation about future events can impact prices. Traders should therefore be aware of news that might affect prices.
- New energy sources: Growth in renewable energy production (i.e., solar and wind) may cause a decline in the dependence on oil, thereby causing prices to fall.
- Global oil production: The Organization of the Petroleum Exporting Countries (OPEC), plus major oil producers like the USA, Canada, and China, are major influences on the oil price and supply. As such, oil prices fall when output increases and rise when output is restricted.
- Exogenous shock: Events like natural disasters, war, and geopolitical instability can severely impact oil prices. When output or supply is reduced due to an unforeseen 'shock' event, panic buying often leads to higher prices.
What is oil trading?
Oil trading involves buying and selling oil contracts with the goal of profiting from price fluctuations.
Traders can participate in the oil market through various financial instruments, including futures contracts, options, and contracts for difference (CFDs). Oil trading provides opportunities to speculate on the price movement of oil without the need to physically own or deliver the commodity. In other words, you do not have to buy a physical barrel of oil to trade it; you simply speculate on whether the price of that oil is going to rise or fall in the open market.
Because of its importance in global commerce – oil is essential to global transport and is a crucial basic ingredient in the production of everything from electricity and plastics to cosmetics and pharmaceuticals – many industries monitor the price of oil very closely and actively trade in the oil market. This gives the oil market a high level of volatility.
How does oil trading work?
The two main ways to trade oil online are cash CFDs and futures CFDs.
- Oil cash CFDs: This involves buying oil at the current market price. This is the simplest way of trading oil and is typically used with shorter contract durations, ranging from a few hours to several weeks.
- Oil futures CFDs: Oil futures contracts are a more sophisticated form of investment than cash CFDs. Oil futures typically have longer contract durations, spanning months or years. If you believed the price of oil would be higher in the future, you could enter into a contract with a seller to agree on a price to be paid today so that when the physical oil is delivered upon contract expiration, you could sell the physical oil for more than what you paid for it.
Let's consider an example of trading oil using a CFD on the West Texas Intermediate (WTI), a benchmark crude oil, where the current market price is $70 per barrel.
If a trader believes the price will rise, they can go long and buy a CFD for 10 barrels of WTI at the current price of $70 per barrel. If the price increases to $75 per barrel, the trader can sell the CFD and earn a profit of $50:
([$75 - $70] x 10 barrels) = $50 profit
Conversely, if the price drops to $65, this results in a loss of $50.
([$65 - $70] x 10 barrels) = $50 loss
Oil CFD trading
As trading oil as a CFD does not involve physical ownership, traders can profit from changes in price in either market direction.
For example, if a trader expects oil to drop from its current price of $70 per barrel in the next few months, they can sell an oil futures CFD contract at $65 per barrel. If the price of oil does drop to the $65 level by the date of the contract's expiration, they will earn a profit of $5 per barrel.
Why trade oil?
Trading oil offers several benefits when compared to other forms of trading and investment.
Firstly, oil is a highly liquid market, so it is relatively easy to enter and exit trades. And because oil prices are influenced by global events, there is a high likelihood that a major event or piece of news somewhere along the supply or demand chain will create price fluctuations and therefore trading opportunities.
Additionally, because oil is such a vital commodity across the world, consistent demand is effectively assured, and the potential for profit remains. Moreover, oil trading allows for diversification as it is less correlated to traditional financial markets such as stocks and indices.
Lastly, because oil can be traded as a CFD, there is no requirement to own any physical product. When combined with leverage, traders can amplify their potential returns. Note, however, that leveraged trading also amplifies any potential losses.
How to trade oil?
Here is a basic step-by-step guide on how to start trading oil in global markets:
- Find a broker: Start by researching and comparing different online brokers that offer oil trading services. Look for brokers that are reputable, regulated, have good reviews from clients, offer user-friendly platforms, have competitive fees, and provide access to the oil market, specifically, the products you want to trade.
- Open an account: Once you've selected a broker, open a trading account. As part of regulatory requirements, for the security of your account and the protection against fraud, the broker should ask you questions about your trading abilities and will require you to verify your identity by submitting your ID and residence documentation.
- Fund your account: Deposit money into your trading account once your application is approved so you have money available to trade with. Most brokers provide a range of funding methods, including bank transfers, credit and debit cards, and online payment methods. Make sure you comprehend any minimum restrictions imposed by the broker and make a deposit that you feel comfortable trading with (and that you might be willing to lose if trades go against you).
- Explore the trading platform: Spend some time learning how the broker's trading platform operates and how to make use of tools like charts and indicators. Learn about the various trades (orders) you can make. Numerous brokers provide demo accounts, which allow you to practise trading without risking any real money. These can be quite helpful in familiarising you with the platform and its functions.
- Conduct market analysis: Review oil price charts, keep up with pertinent news, examine fundamental and technical aspects that can affect oil prices, and conduct market analysis before placing a trade to gain an understanding of the current oil market circumstances. Use the materials and analytical tools provided by the broker to supplement your study.
- Place a trade: Once you have a trading strategy in mind and have conducted your market analysis, it's time to place a trade! On the trading platform, select the oil market or instrument you want to trade (e.g., crude, WTI). Choose the order type (e.g., market order or limit order) and the quantity (e.g., the number of barrels of oil). Remember to also set stop-loss and take-profit levels to help manage potential risks and returns. You’re now ready to execute the trade!
- Monitor and manage your trade: After placing a trade, you should monitor your position regularly. Track oil price movements, market news, and any relevant events that can impact your trade. If you haven’t already, consider using stop-loss and take-profit orders to automate the management of your trade. This is where you should be prepared to adjust your position or exit the trade if market conditions change.
- Review and learn: Once the trade is closed, review your performance, evaluate the outcome, and do your best to be honest and impartial. Analyse what worked well and what could be improved in your trading strategy so you can learn, especially from mistakes. Keep refining your skills with educational resources, webinars, and market insights provided by the broker.
Advantages of trading oil
- Accessibility: Oil CFD trading provides easy access to the oil market for individuals without the need for physical ownership of the commodity. Traders can speculate on oil price movements without the logistical challenges of handling physical oil.
- Leverage: CFD trading allows traders to take advantage of leverage, which means you can control a larger position with a smaller amount of capital. This amplifies potential profits (and losses) compared to the initial investment.
- Diverse trading opportunities: Oil is a global commodity with substantial market liquidity, which offers a wide range of possibilities. Traders can speculate on different types of oil, such as Brent crude, WTI crude, or other regional grades.
- Market volatility: The oil market is known for its volatility, which presents traders with opportunities to profit from price fluctuations. Increased volatility can lead to greater potential returns.
- Long and short positions: CFD trading allows traders to take both long (buy) and short (sell) positions. This means you can profit from both rising and falling oil prices by speculating on the direction of the market.
- Hedging: Trading oil as a hedging instrument can be a useful way to diversify and balance risk in an investment portfolio
- Flexibility: Oil CFD trading offers flexibility in terms of trade sizes, allowing traders to enter positions with smaller amounts of capital compared to traditional futures contracts.
- 24/5 market access: The oil CFD market operates 24 hours a day, 5 days a week, providing a range of trading opportunities across different time zones. Traders can react to global events and news that impact oil prices without being limited by exchange hours.
- Risk management tools: CFD trading platforms typically offer risk management tools such as stop-loss and take-profit orders. These tools allow traders to set predetermined levels to limit potential losses or secure profits automatically.
Disadvantages of trading oil
- Risk of losses: CFD trading carries a high risk of potential losses. When trading with leverage, small adverse price movements can result in significant losses.
- Volatility and price fluctuations: While volatility can present trading opportunities, it also increases the risk of rapid price fluctuations, which can lead to unexpected losses. The continuous monitoring of price movements may be necessary.
- Complex market analysis: Successful oil CFD trading requires thorough market analysis and an understanding of the factors that affect oil prices. Supply and demand dynamics, geopolitical events, and economic indicators can be complex and challenging to analyse for anyone new to trading.
- Overnight financing charges: Holding CFD positions overnight may incur financing charges, also known as swap rates or rollover fees. These charges can eat into profits or increase losses if positions are held for an extended period.
- No asset ownership: The lack of physical ownership of the underlying asset may not appeal to some traders.
What are the best oil trading strategies?
As it is a volatile market, oil requires careful analysis to be traded successfully. Fundamental analysis and technical analysis are the two main approaches that traders use to evaluate the oil trading markets.
- Fundamental analysis: Because of its importance to the global economy, oil is always in the headlines. There are some regular announcements and data releases, however, that are essential reading for oil traders, such as those from the Energy Information Administration (EIA) Crude Oil Inventory and the Organization of Petroleum Exporting Countries (OPEC) Joint Ministerial Monitoring Committee. The EIA measures the change in the number of barrels of crude oil held as inventory by commercial firms from the previous week. OPEC is the organisation that moves the oil market the most by discussing a wide range of issues relating to energy and agreeing upon how much oil should be produced by each country.
- Technical analysis: Technical analysis is a skill that can be easily learned but not always easily mastered! To perform technical analysis, you apply indicators to charts, which can help identify trends and risk sentiment in the market. By combining this with your own assessments of the price action of oil products, you can discover entry points to the market and use them to attempt to generate profit from price movements.
Ready to trade your edge?
Join thousands of traders and trade CFDs on forex, shares, indices, and commodities!
This information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. It has been prepared without taking your objectives, financial situation, or needs into account. Any references to past performance and forecasts are not reliable indicators of future results. Axi makes no representation and assumes no liability regarding the accuracy and completeness of the content in this publication. Readers should seek their own advice.