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Lesson 101: Trading in the Oil Market

By Louis Holding-Parsons on April 18, 2019

5 (100%) 1 vote[s]

Trading in the oil market can be as scary as the price of a tank of fuelFor regular drivers, a sudden increase in the price of oil can be a shock. The savvy among us will have noticed that it is cheaper to buy petrol outside of major cities. Petrol stations charge less on the outskirts. Although reducing one’s daily cost is attractive, how can you use oil to increase your wealth by trading in the oil market?

How oil is priced

Brent crude or more formerly known as Brent Blend is one of two internationally recognised oil prices, the other being West Texas Intermediate, better known as West Texas Crude. Trading profitably means having an understanding of what you are trying to trade so as to avoid the pitfalls. This also means you can take advantage of the opportunities! At a simplistic level, oil is priced based on supply and demand. Too much supply and it goes down, with strong demand causing it to go up. Yet there are more complicated influences: a war involving a major oil producing country or even the threat of a war can move the price. A suspected cut by OPEC or even the lack of a cut can also influence the price.

Share price gains…

Trading in the oil market could mean buying publicly listed sharesAnother way of trading in the oil market is through publicly listed shares. Major oil companies such as Shell and BP’s performance (and their share prices), are tied to the price of oil. Their profits are used to pay out big dividends to their shareholders. As major companies they are able to sustain dividends even when the oil price drops severely as it did in 2016. The ability to profit from both capital and income means the total gain from trading these shares is not to be snuffed at. As with all share prices, one should be aware of their inheritant volatility and the possibility of losing everything.

Trading oil currencies

From a Forex trading perspective, you can also profit trading in the oil market, through the currencies of countries whose economic wealth is dependent on the oil price. Within the larger currencies this involves the Canadian Dollar (CAD) and Norwegian Kroner (NOK). Both these countries are heavy exporters of oil, indeed the USA imports the largest percentage of its oil from Canada. Norway has generated so much profit from its oil that it has even created an oil fund. CAD is also considered one of the comdolls currencies. Comdolls is short for Commodity Dollars and is so called because the value of the CAD is affected by the price of commodities.

Using arbitrage when trading in the oil market

Trading in the oil market may mean buying, holding and eventually selling an oil related financial instrumentAnother way of trading in the oil market is by the use of futures. You enter a contract to take delivery of oil in the future at a particular price and date. Except most future contracts are never actually completed, because they are merely entered into for speculation purposes. If you thought the price of oil will be higher in 6 months time, you would enter into a futures contract to buy oil in 6 months at today’s (lower) price. In 6 months time you would be able to sell your oil at a higher price, pocketing the difference. This is called arbitrage. Occasionally the forward price of oil is lower than the “spot” price (the price you get today). This is when the market is in backwardation. You should be aware that this is the higher risk approach. Futures are considered derivatives, which are are advanced financial tools.

All roads lead to Saudi

Finally anyone trading in the oil market will have to keep a firm eye on Geopolitical risk. OPEC and Saudi Arabia in particular have the ability to move the oil price with just a brief public statement. You can make money news trading, but a war in an oil producing country or political instability (think Libya and Venezuela respectively) will often lead to the oil price rising because of the threat of the reduction in supply.

Conclusion:

Trading in the oil market can be easily started through opening an account with an online trading platform. Yet there are different ways of doing so. A good appreciation of geopolitics will be a must as the oil price is tied to world economic growth. As with all things related to trading, understanding what you are investing in and finding the solutions which fit you are paramount. The riskiest involves using derivatives and arguably the safest is through Forex trading. Currencies are seen as safer due to being a zero sum game. 

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Louis Holding-Parsons

Louis is a portfolio manager and a trader who brings a wealth of experience in private banking to The Lazy Trader. A fundamentalist and a trouble-shooter, Louis makes a firm contribution to the trading team.

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Louis Holding-Parsons

Louis is a portfolio manager and a trader who brings a wealth of experience in private banking to The Lazy Trader. A fundamentalist and a trouble-shooter, Louis makes a firm contribution to the trading team.

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