Crude oil is one of the most liquid assets in the commodities market, with more than $80 billion worth traded on a daily basis. However, its vulnerability to market fluctuations, external influences and trader sentiments means that it can also be one of the most volatile. Still, trading in crude oil can be a profitable venture, so here are five of our top tips that can lead to a trading success.
1. Understand what moves the price of crude oil
To be successful in oil trading, you must understand what moves the value of the asset. As a physical asset, the main factor that affects this is the relationship between supply and demand; the most common market mover for any commodity.
When there is an increase in supply, and a lack of demand, there will most likely be a reduction in price, and traders would be looking to sell. This was dramatically evident in the spring of 2020, when there was surplus of supply and hugely depleted demands, so oil prices dropped to a negative price, for the first time in oil trading history. On the other hand, an increase in demand and a decline in oil production, would lead to a rise in oil prices.
It is also important to know where oil comes from, and therefore the effects of geopolitical events and environmental factors. The Organization of Petroleum Exporting Countries (OPEC) is made up of several countries that collectively manage the amount of oil produced. This makes the likes of Russia and American, the non-OPEC countries, a competitor of oil production. Any news or actions from the OPEC would affect the supply, and therefore oil prices. Likewise, political turmoil or uncertainty, or a national conflict, can also have an effect on the oil market and lead to a movement in price.
2. Choose which oil to trade in
You must have knowledge of the different types of oil, and decide which one you’d like to trade in. There are two primary types, that are used as key benchmarks for oil prices in the market: West Texas Intermediate Crude (CL), also referred to as WTI, and Brent Crude (EB), which is known as just Brent. The location of these oils can have an effect on their movement, as WTI is sourced in the US, and is mostly extracted from land wells, which can make it more expensive to export. Whereas Brent is extracted from the North Atlantic, and therefore is a lot easier to ship. The prices of each usually move in the same direction, but development of the ways in which these two oils are produced, has seen the pricing between them sometimes diverge.
3. Understand the market sentiment
As a successful trader, you must have a good understanding of the market sentiment, which can contribute to trend momentum. Market sentiment is the overall attitude of investors towards the market. It can shift the price of oil and influence the availability of future contracts, if there is a sudden surge of interest. This in turn will alert other traders to the price movement, and so further increase trading volume; as forementioned, an increase in demand will raise the commodity’s price.
On the other hand, if the market sentiment is that of lacking interest, the market could be influenced by the idea that oil is devalued, with traders discouraged from investing. With a lack in demand, it may lower the value of the commodity.
4. Do your research
As a successful trader, research is one of the most important things you can do. Research the market, the asset, and its trading history. Read articles and books on crude oil to learn the historical background of the commodity. This will not only put you in a good position to understand the asset itself, but also how it works, how the market moves and what future trends may involve.
5. Develop a trading strategy
Now you know which oils are the major market benchmarks, and what can impact the market, it’s time to develop your personal strategy for trading crude oil. A strategy to consider, is to trade in both WTI and Brent simultaneously, but with different sizes of position, to hedge any losses in one with profits from the other.
In general, your strategy should be a holistic approach, and will involve all of the factors above, as well as an understanding of the technical indicators and charting. Technical factors can also determine the price of oil. Traders should be able to read the long-term chart, as well as use technical indicators to determine the trends and price movements. The Relative Strength Index (RSI), for example, is commonly used to analysis the market sentiment, and oversold or overbought positions.