How to Trade and Invest in Oil
Summary: This in depth guide covers the basics of investing in oil, trading options, market prices and how to trade and invest in oil with Saxo Bank.
Oil is a multi-trillion-dollar market. A report by Research and Markets predicts that the oil and gas industry will grow 6% by 2025, taking its total value to more than $7.4 trillion. With this being the case, it's hardly surprising that oil is one of the most traded commodities in the world. It achieved this status because many aspects of modern life are dependent on oil. Even with an increased move towards green energy and ESG stocks, oil will be a leading commodity for many years to come.
Given that oil is a highly traded commodity, there’s a high degree of liquidity in the market. In turn, there are many ways to invest. This guide explains the basics of oil trading and outlines the ways you can invest. As with all investments, your capital is at risk and there are no guarantees of positive returns. However, oil is a well-established financial market, and, with a bit of knowledge, there is a lot of potential depending on your trading strategy and how the market moves. So, with this in mind, here’s how to trade and invest in oil.
- What is Oil Trading?
- Types of Oil Trade
- What Influences the Price of Oil?
- What is the Best Way to Invest in Oil?
- Invest and Trade Oil at Saxo Bank
What is Oil Trading?
Before we explain the nuances of oil trading, let’s address the question: what is oil? Oil, known technically as crude oil, is a fossil fuel. It exists in liquid and gaseous states in underground reservoirs. Oil companies have to drill down beneath the earth’s surface to extract it. This process takes place on oil rigs located offshore.
Trading oil online is the process of purchasing and selling financial instruments to make a profit. How you can trade oil will vary. For example, you can invest in the actual commodity, or you can speculate on price movements using contracts for difference (CFDs). Whichever way you invest in oil, the overall aim is to make a profit. Of course, making a profit is never guaranteed in any form of trading.
When you’re learning how to invest in stocks, there are a variety of metrics you need to assess. For example, you can use a stock’s yield over time to determine if it's potentially profitable. With oil trading, you have to look at similar metrics. There are different varieties of crude oil traded online, but there are two main benchmarks against which all others are measured:
West Texas Intermediate (WTI) – Considered one of the leading standards for oil prices. WTI oil is produced in North America, and it’s used as a measure to consider both supply and demand within the oil market. You can trade WTI futures on the New York Mercantile Exchange (NYMEX), which is a section of the Chicago Mercantile Exchange (CME).
Brent Crude – This type of crude oil is produced in the North Sea. It’s the main benchmark for oil prices, as well as supply and demand, in Europe, the Middle East and Africa. You can trade Brent Crude futures on the Intercontinental Exchange.
Types of Oil Trade
There are six main ways to invest in oil at Saxo. You can choose any or all of the following, but make sure you understand the mechanics of each before you invest any money:
Futures contracts allow you to buy or sell a commodity for a predetermined price at a future date. One aspect to consider is that depending on how you enter the contract, you could be expected to either receive or make delivery of the commodity. In other words, you’re paying for barrels of oil that you’d need to take receipt of and store. The good news is that most oil futures you’ll buy online will settle with cash instead. Finally, oil futures are traded by the barrel. A single future is equal to 1,000 barrels and, with a contract worth almost $100,000, you need to invest a large amount to trade oil futures. You can trade on margin, but there is still a minimum exposure which could be a five-figure sum.
Oil Commodity CFDs
It is possible to trade oil commodities using leverage. In this context, leverage allows you to increase your exposure to a financial instrument by trading with borrowed funds. Basically, you put up a small amount of capital and the broker will put in the rest of the money required to buy the instrument. This amplifies your potential profits, as well as risks. Leverage in the context of CFDs allows you to speculate on the price of a commodity (i.e. oil) increasing (going long) or decreasing (going short). You do not own the undying commodity and are speculating on the movement.
So, if you buy shares in a company, you own it. You have a stake in the company and, therefore, make money if its value increases and lose money if it decreases. You don’t own anything with a CFD, other than an obligation to buy/sell a contract at a point in the future. This means you can speculate on the price of an instrument increasing or decreasing.
Options are a type of trading whereby you purchase the right to buy (a call order) or sell (a put order) an asset for a certain price on or before a given date. Specifically, oil options are a type of futures contract. However, as the name implies, you are not obliged to fulfil this contract if you decide against it. That’s because you’re not buying or selling an asset, nor do you have to take receipt of the oil like you would with a standard futures contract.
Therefore, you don’t have to fulfil a contract to buy the oil. That means you can only lose the cost of the option, rather than the value of the underlying futures contract. This type of trading is used for hedging, income, or to speculate on future prices.
You can buy stocks in refineries that deal in oil production. You’ll own a piece of the company and, therefore, have the potential to receive dividends and voting rights. Oil stocks are like any other stocks. This means you buy/sell them immediately at whatever the market value is.
It’s also possible to buy stocks in platform operators, drilling companies, and any other business that’s part of the oil extraction process and supply chain. This can be important because you can change your investment portfolio to invest in a particular aspect of the oil production process.
You can invest in a variety of oil stocks using ETFs. An oil ETF tracks the performance of multiple stocks from the industry.
Single Stock CFDs
What Influences the Price of Oil?
The price of oil will fluctuate based on a variety of factors. Supply and demand are the overarching dynamics that govern the market. However, within these two categories is a plethora of triggers. For instance, extraction issues can affect the supply chain. Oil supplies may also be restricted based on corporate and/or government decisions.
For example, OPEC (Organisation of the Petroleum Exporting Countries) is made up of representatives from 13 major oil producing nations. As a collective, OPEC can influence the price of oil in countries its member nations supply based on political and economic needs and attitudes.
It’s the same with other major oil producing nations. The US, China, Canada, and Russia all supply oil to countries around the world. When these countries are hit with major political incidents, such as wars, the price of oil will fluctuate. Therefore, it’s important to consider the source of oil supplies and what’s happening in those countries politically and economically.
Demand Can Swing the Price of Oil in a Different Direction
On the flip side, the oil demand can also be affected by politics, as well as economic and health-related events. For example, during the COVID-19 pandemic, international lockdowns meant travel was restricted. This caused demand for oil to drop significantly and, in turn, the markets to dive. Therefore, if you’re going to trade oil, you need to consider a variety of factors.
When demand is high, and supplies are low, the price of oil typically increases. When demand is low and supply is high, the price typically decreases. Of course, this isn’t always the case. However, if you use the two main benchmarks for the industry (WTI and Brent Crude), you’ll see that their prices almost always follow these patterns.
How to Invest in Oil
You can trade oil at Saxo by following these steps:
- Create an account at Saxo Bank. Note: You’ll need to enter your personal details, including your National Insurance Number. You’ll also need to verify your identity and confirm that you understand the risks involved in any financial investment.
- Choose your account type: Classic, Platinum or VIP.
- Make a deposit equal to or greater than your account type’s minimum funding requirement.
- Search for the type of product you want to trade, e.g. stocks, CFDs, futures, options or ETFs.
- Enact a trade.
What is the Best Way to Invest in Oil?
The best way to trade oil is to find a strategy that suits your level of experience and the amount of risk you’re willing to accept. If we were to create a possible hierarchy of investment and trading options, based on their complexity, funds required, and possible risks, it would look like this:
Best Ways to Invest in Oil
Best Ways to Trade Oil
Investing in Oil
The most straightforward way to invest in oil is to buy and sell stocks. You’re buying/selling on the spot, which means you pay/receive the price when the transaction is made. This eliminates the need to understand futures contracts, options, and CFDs. In simple terms, you’re buying or selling shares in a company. If a share costs $100, you’ll pay $100 and own it. That means you have a small stake in the company.
However, the issue with stocks in trading oil is that they have more distinctive risks than things such as ETFs. That's because individual events can affect the value of a company and, therefore, its stock. With ETFs, you have a broader range of interests and, therefore, individual events aren't necessarily as damaging.
Below are the three ways to trade oil going from what could be more suitable for novice traders:
Use CFDs as a Flexible Way to Trade Oil
If you want the ability to take either side of a proposition (the value of something increasing or decreasing) you can trade oil CFDs. Going long means you believe the price will increase over time. Going short means you believe the price will decrease over time. Having the ability to take either side of a proposition can be useful, particularly in volatile markets. However, it's also important to understand that CFD trading contains risk.
The main reason CFDs can carry more risk is leverage. As we explained earlier, leverage means you're borrowing money from a lender to achieve greater market exposure. That means you can make more money than you otherwise would when things are going well. However, it also means you can lose more money when they’re not. Essentially, because you’re multiplying your stake to buy CFDs with leverage, you’re risking multiplying your losses.
It's also the case that you can trade with lower amounts than you can with futures because, as we explained earlier, futures require a substantial investment. Therefore, this may be a more suitable option for those with smaller bankrolls. However, it's important to understand that leverage can also magnify your losses. Therefore, if you do want to trade CFDs, you need to be aware of the risks involved and, in turn, how to use leverage.
Spread Your Risk with ETFs
If you want to spread your risk and track the price movements of multiple companies, Exchange Traded Funds (ETFs) are an option. As with all investments, there are risks involved in ETFs. However, these products allow you to invest in a fund that tracks the performance of multiple companies.
The potential upside of trading ETFs is that your investment doesn't hang on a single company. If we look outside of the oil industry for a moment, ETFs tracking the S&P 500 cover the 500 largest companies in the US. If a handful of these companies are performing poorly, it won't necessarily affect the ETF's value (or affect it as dramatically) because other stocks might be performing better than expected. This is why ETFs can be described as a way of spreading your risk.
To get the most from ETFs and any other oil investment, you need to understand how markets fluctuate. This isn’t an exact science. However, once you’ve traded oil for a while, you can use technical analysis to try and forecast how the markets are moving.
Invest and Trade Oil at Saxo
Oil may not be the right investment option for you, but the market undoubtedly has plenty of potential. Trading volume is high and there are multiple ways you can buy and sell oil. The most important thing to remember is that nothing is ever guaranteed. Any investment can have positive and negative results. Therefore, as well as using this guide to understand the basics, you need to do your research and monitor the markets.
Learn to use technical indicators, read company reports and watch the news. Finally, you can use the webinars, the Saxo Market Call podcast for daily insights on commodities and more, and trading updates to guide your decisions. When you take time to immerse yourself in the financial markets and only invest amounts you can afford, you’ll have the best chance of making a profit when you trade and invest in oil online.
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