Adding crude oil to your investment portfolio offers good risk diversification. However, it can be quite intimidating to dive into crude oil without the proper experience and expertise in navigating the said market. Use the five tips below to gain firm footing before you make your first trade on oil.
Figure Out What Moves It
Traders often fail to capitalize on the opportunities abundantly provided by the oil market. A common reason for this is most traders are unaware of the unique market characteristics that surround crude oil. Start by looking at the energy sector and then moving into more specific supply and demand factors that affect the price of oil. Keep in mind that not all financial assets categorized under the energy sector are created equally. Oil will have slightly or completely different technical and fundamental catalysts that drive its price. Imbalances in supply and demand will cause oil price to drop and rise accordingly.
Determine Who the Major Players Are
As a retail trader, your positions in crude oil will likely be dwarfed by the sheer size of positions entered by professional traders and hedge funds. These parties dominate the financial markets and have more resources to put into research and formation of tradable ideas. Knowing which direction they are betting their money in makes strategic sense for smaller players like you. On the same note, avoid becoming a part of the herd and mindlessly taking positions in whichever direction big players take. Instead, try and think for yourself by looking at the fundamental factors driving price momentum and trend.
Choose Your Market
Oil can be traded via two main markets – WTI and Brent. You may have seen these two types of oil market from business and finance channels or upon viewing online charts. Regardless, WTI or Western Intermediate oil is sourced from the US Permian Basin while Brent oil comes from the Northern Atlantic. The difference in origin has led to significant differences in sulfur content and API gravity. Between the two markets, Brent is considered a more reliable indicator for global pricing of oil.
Start With Oil Futures Contracts
Crude oil futures contracts can be bought and sold via the NYMEX, short for New York Mercantile Exchange, and TOCOM, or Tokyo Commodity Exchange. Futures contracts involve an agreement to purchase or sell a specific amount of crude oil at a predetermined value at a future date that is also specified within the contract. Crude oil futures contracts use dollar and cents per barrel as its denomination and 1,000 barrels is the minimum trade size. For this very reason, some argue that oil futures contracts tend are relatively riskier than other commodities.
Risk management should be at the pinnacle of one’s trading routine if he/she desires future success. Manage risk of your crude oil positions by limiting the position size to an extent that it is not susceptible to getting margin called. Furthermore, as a beginner, it is advantageous to use a longer term strategy rather than scalping or day trading. It is exceptionally risky to trade shorter time frames and should only be done so once you’ve acquired the proper know-how and tools.
Becoming a successful crude oil trader takes time. Dedicating at least one hour per day to analyze the market as well as positively correlated markets will help you stay on top of price action and position your capital in low-risk, high-profit trades.