Crude Oil: Should You Invest in Oil in 2022? | Forex oil trading
Oil volatility creates many trading opportunities for traders and can be used to diversify a portfolio and hedge investments in other assets. But how can oil be traded on world markets?
Traders have three options: trading futures, trading contracts for difference (CFDs), or investing in companies or ETFs related to the oil sector. In this article, we will look at how and why oil prices move, what factors affect oil prices, and how traders can invest and trade oil.
Crude oil: definition
Crude oil is crude oil and fossil fuels that are made up of deposits of hydrocarbons and other organic materials. It can be recycled to produce useful products such as gasoline, diesel fuel, petrochemicals (such as plastics), fertilizers and medicines.
Oil is the main and most important component of the world economy, and according to the International Energy Agency (IEA), the total world consumption of oil is about 99 million barrels per day. No wonder oil has a big impact on our daily lives and is therefore closely watched by economists, businessmen and traders.
WTI stands for West Texas Intermediate. It is one of the two most popular and well-known reference grades of oil. The second is Brent oil.
WTI, also called US Crude, is a high quality crude oil that is exported and used all over the world. WTI crude refined in the United States is a light, sweet crude that has traditionally cost $1-2 more than Brent crude.
WTI is also a reference oil, that is, its price serves as a guide for buyers and sellers of crude oil, and in the media it is its price that is indicated as the cost of oil in the world.
Brent oil refers to crude oil produced from the Brent oil field in the North Sea. It is the second most popular oil and, like WTI, is also a benchmark for oil prices.
Brent oil is mainly produced in the North Sea and refined in Northwest Europe. Brent is the main grade of oil in Europe and North Africa.
What is an OPEC basket?
Another important factor in the world market is OPEC (Organization of Petroleum Exporting Countries).
The OPEC oil basket includes seven different types of crude oil coming from Saudi Arabia, Nigeria, Algeria, Dubai, Venezuela, Indonesia and the Isthmus of Mexico. More sulphurous and heavier (compared to WTI and Brent), OPEC oil is usually cheaper, but still plays an important role in the world market.
Crude Oil: Comparison of Brent and WTI Oil
While both Brent crude and WTI crude are popular trading vehicles, there are five key differences between them:
Where it is produced: WTI crude oil is extracted and produced in the United States, primarily in Texas, North Dakota and Louisiana. Meanwhile, Brent crude oil is mainly produced from oil fields in the North Sea.
Geopolitical difference: political activity often affects oil prices, in other words, the political situation in oil producing areas can affect prices and oil trading activity. Today this is more relevant for OPEC oil than for Brent or WTI.
Composition: The composition of oil also affects the price of WTI and Brent: the most important characteristics are the API degree, which is a measure of how heavy the oil is compared to water, and the sulfur content. The sulfur content of WTI crude is 0.24% compared to 0.37% for Brent crude. The lower sulfur content makes it easier to clean up the oil.
Oil trading options: Brent and WTI also offer different trading options, including futures contracts and CFDs. Oil futures are available on different exchanges (WTI on the New York Mercantile Exchange, Brent on the Intercontinental Exchange), while many brokers offer the ability to trade CFDs using a single platform.
Prices: In theory, WTI should trade more than Brent oil, but this is not always the case. The reason for this is that not only the quality of the oil itself affects its price, there are a number of factors. One of them is supply and demand, for example, when the supply of oil increased during the shale revolution in the early 2000s, the price of oil fell.
What affects the price of oil?
The movement of oil prices plays an important role for traders, investors and the global economy. Rising oil prices increase costs to consumers both directly (fuel at a gas station) and indirectly (petroleum-derived products or the fuel companies use to make products). Ultimately, cheaper oil means lower costs for consumers.
Here are the results of oil price changes in the long term:
- Higher oil prices tend to drive up the cost of products, which in turn undermines economic growth by creating the potential for higher inflation and higher interest rates.
- Lower oil prices tend to lower the cost of products, which in turn stimulates economic growth by reducing the likelihood of higher inflation and rising interest rates.
- Very low oil prices could reduce supply as producers are more likely to cut current oil production or put new oil projects on hold.
- Oil prices are constantly changing - every day and every minute. Oil prices are affected by a wide range of factors.
Let's consider the main ones:
- Increase or decrease in supply from oil producers
- Increase or decrease in demand from consumers and oil importers
- Subsidies for oil companies or other energy companies
- International politics (agreements between countries)
- Domestic policy of the oil producer
- Competition from other energy sources
- Geopolitical tensions and insecurity (usually driving up prices)
- The use of oil and its future prospects
Perhaps you are also wondering how supply and demand affect the price of oil? Generally, if supply exceeds demand, prices go down, while if demand exceeds supply, prices go up. There are two main factors influencing supply and demand. Let's take a look at them.
Oil supply: the impact of oil production
Oil is a resource that is not found in every country, so oil is only produced in certain places. Oil is produced in 100 countries, i.е. in about half the countries of the world. Five of them account for 49.6% of the world's total crude oil production. Thus, oil-producing countries and oil associations (such as OPEC) have more power to control their supply and influence the price.
They can cut oil production to stop prices from falling or help them rise. They can increase oil production if they think the price is good (i.e. oil is expensive enough) to sell it for a profit.
Oil Demand: The State of the Global Economy
Demand for oil rises when the global economy develops: consumers buy more products, companies ship and transport more goods (due to higher demand), companies invest more (to create sufficient production capacity), and consumers make more business and leisure trips . The weakening of the world economy has the opposite effect and reduces the demand for oil.
How geopolitics affects the price of oil
With just five countries producing almost half of the world's oil, political tensions in one of these countries could lead to serious supply problems. For example, war or conflict in an oil-producing region could jeopardize reserves, production or refining capacity, causing oil prices to rise sharply.
That is why a trader should monitor the geopolitical climate in the main oil producing countries.
Oil trading: advantages
As one of the most popular assets to trade and invest in the world, crude oil trading provides you with a number of benefits.
Volatility (strong price fluctuations) in oil prices is probably the most obvious advantage of trading WTI and Brent crude oil. Fluctuations in oil prices are usually significant. The up and down movement of the price gives traders the opportunity to capitalize on these fluctuations through intraday, intraweek or swing trading.
A large number of traders and investors “keep all their eggs in one basket”. For example, in many Western countries such as the US, UK and Australia, people primarily invest in real estate, while in other countries assets such as stocks make up a significant portion of personal wealth.
The danger of this lies in the fact that if even one market starts to fall, the entire investment portfolio can be destroyed. Diversifying your portfolio by investing and trading in different markets will help mitigate this risk.
Investing in commodities such as oil is one effective way to diversify your portfolio and manage risk.
3) Trading based on fundamental analysis
Many markets are intimidating for new traders, so it is often necessary to use technical analysis to be successful in them. However, the oil market is heavily influenced by factors related to fundamental analysis, such as the aforementioned geopolitical tensions. This means that if you follow the news regularly, you will be able to find interesting trading opportunities.
Buy Oil: Should You Invest in Oil Now?
At this moment, when the markets are uncertain, the coronavirus pandemic continues, inflation is rising around the world, and conflict of incredible proportions has erupted in Eastern Europe, volatility has skyrocketed and oil has begun to move upwards.
From the start of the pandemic in March 2020 until today, crude oil has been on an upward trajectory. Two years later, on March 3, 2022, Brent oil broke the $120 per barrel mark for the first time since April 2012.
Growing demand for oil in light of the gradual recovery of the global economy and the easing of restrictions imposed in connection with the pandemic, contributes to the growth of prices for “black gold”. At the same time, OPEC+ members have constantly held back the pace of oil production, and the supply chain is still experiencing problems due to the pandemic. All this has led to the fact that over the past months, crude oil has been gaining strength. The latest surge in prices came as tensions in Eastern Europe reached a boiling point.
Given all of the above factors, it is likely that oil prices will continue to rise and volatility will increase. Remember that volatility increases risk, so it is important to manage risk when investing in oil in the stock market.
How to invest in oil: options
The oil market is very interesting in terms of trading and investing, as it offers various options. These include buying crude oil, buying oil stocks, trading oil futures, investing in oil ETFs, and trading oil CFDs.
#1 Buy Crude Oil
It can be assumed that the easiest way to invest in crude oil is to buy a barrel and then sell it at a higher price once the price of crude oil rises.
In fact, it is quite difficult for a retail trader or investor to invest in a physical barrel of oil. Unlike some other commodities, such as gold and silver, oil is difficult to store, highly toxic, and requires good insurance in case you manage to get your hands on it.
The good news is that there are a number of other, much more practical ways to invest and trade oil.
#2 Oil on the exchange: Stocks
The first option for investing in oil and, ideally, making a profit if the price rises, is to buy shares in companies involved in the exploration, production and processing of oil. These companies include such global giants as BP, Royal Dutch Shell, Exxon Mobil and Total SA.
The problem with this approach is that since you are not directly investing in oil, the stock price of the companies you invest in may not always reflect changes in the price of the oil itself. This is because there are a number of other factors that affect the valuation of a company's shares, such as dividends, management and regulatory changes that can affect the business.
#3 Invest in oil through ETFs
The next oil trading option is investing in ETFs (exchange-traded funds) for oil. An ETF is an asset that is a basket of other assets (such as stocks) that an investor can trade or invest in. The main advantage of this tool is that it gives the investor the opportunity to invest or trade in more markets, rather than looking for individual instruments to invest in.
For example, if an investor wants to invest in US tech stocks but doesn't want to analyze individual stocks, they can find a ready-made ETF that tracks the US tech stock market.
There are a number of commodity ETFs available, including oil ETFs. They may include oil stocks as well as crude oil futures.
As with investing in other assets, traditional ETF investing involves buying an exchange-traded fund and selling it after the ETF has increased in value, i.e. you earn by profiting from the difference between the buy and sell prices.
However, it is also possible to trade ETFs with a derivative instrument called a CFD, which allows you to trade both ways (so you can profit from both rising and falling markets).
#4 Oil trading on the stock exchange: Futures
The next option is trading in oil futures. This is a popular trading option for WTI and Brent oil.
A futures contract is a legal agreement to buy or sell an asset at a predetermined price at a specific time in the future. From a trading point of view, a trader is not interested in getting the asset itself (usually 1000 barrels of oil), but simply trading the contract itself for profit.
For example, oil futures are trading at $55 per barrel. If a trader believes that the price of oil will rise before the expiration of the contract, he can buy the contract now, hoping that he will close the contract at a profit.
If the price of oil rises to $58 by the time the contract expires, or if the trader decides to close it, he will earn $3 per barrel, i.e. $3,000 per futures. However, if the price drops to $54, he will lose $1,000.
Please note that when trading oil futures, traders do not need to pay the full price of the contract ($55 x 1,000 barrels of oil). Instead, you need to make an initial payment, which will be used as margin and usually amounts to several thousand dollars.
#5 Forex oil: CFD trading
The last crude oil trading option is CFD trading. CFD (Contract for Difference) is a tool that allows you to trade on changes in the price of crude oil, but without owning physical contracts or having to invest in a physical asset.
Forex Oil Trading: Strategies
Once you have found a broker that will allow you to participate in online oil trading, it is best to think about how to trade oil (WTI) from a strategic point of view. It is very important to properly manage risk when trading, but it is also important to apply specific oil trading strategies. Most trading methods can be divided into different styles and timeframes.
Here is a summary of the main methods for trading CFDs on oil, commodities and other products and financial instruments:
Fundamental Analysis: Reading, analyzing and using data, news and announcements to estimate future supply and demand
Technical Analysis: This method analyzes price charts using candlesticks (or bars) and indicators to pinpoint trading setups that offer a higher probability of profit and capital gains in the long run.
Wave Analysis: This method analyzes the price patterns on the chart, which makes it possible to understand the context, market structure, and trading opportunities.
- Long-term traders use longer time frames - weekly or daily charts.
- Swing traders use medium time frames - 4-hour and daily charts.
- Intraweek traders use medium-low charts - 1-hour and 4-hour charts.
- Intraday traders use the lower time frames of the 15 and 60 minute charts.
- Scalpers use very low charts - 1-minute and 5-minute charts.
Various combinations of timeframes for oil trading
Although traders can combine any time frame and style and create a huge number of strategies, only a few of them are the most common:
Fundamental analysis and long-term trading: When traders trade WTI using fundamental analysis, they can use long-term forecasts to open a long-term trade on long time frames - if available. Fundamental changes happen more slowly, so this style of trading will require fewer trading setups and will also require less of your time.
Fundamental analysis and short-term trading: When traders create a trading strategy based on the news, they usually stick to short and fast trading setups that are executed on shorter time frames. These types of traders use special tools that provide them with economic news, forecasts and more.
Wave Analysis and Medium to Long Term Trading: Wave patterns are best used for trading 1-hour charts or even longer timeframes. Once you start using this type of analysis, you will probably find it more comfortable to work on 4-hour charts (and longer). The reason is that it takes experience to interpret wave patterns and it is easier to understand and interpret chart dynamics with longer timeframes compared to a fast moving chart such as a 15 minute chart.
Technical Analysis and Medium Term Trading: Technical analysis can be used for long term trading and long time frame charts, but is more commonly used for making quick market entries and exits. Traders can also use technical indicators to create a more robust trading plan, such as trendlines, moving averages, Fibonacci, and oscillators.
Technical analysis and short-term trading: scalpers tend to use trading indicators that do the calculations automatically. They use indicators like Parabolic, Keltner Channel and Pivot Points rather than manual indicators like trendlines and Fibonacci because price moves fast on shorter timeframes and decisions need to be made at the same speed. .
A combination of all three: Some traders do not want to limit themselves and prefer to combine all three methods into a common approach. While there are some advantages to this approach as it provides different points of view, there is also a risk that there will be too much analytical data and the trader will not be able to make a decision in time.
Oil is one of the most popular commodities among investors and traders and has a number of advantages. In the current environment, energy markets are highly volatile. This fact is good news for traders, since the market is likely to experience strong price fluctuations. However, remember that proper risk management practices are very important for traders in an environment of high volatility.