How to trade oil
Crude oil trading is a popular activity for commodity traders. Here’s how you can get started with oil trading.
How to trade oil for beginners
Examining the oil market
When we say trading oil, we do not mean physically exchanging cash for a barrel of liquid crude. Instead, we’re looking at the different financial instruments that are used by commodity traders to buy and sell oil.
The two most commonly traded oil varieties are WTI (West Texas Intermediate) and Brent Crude. These are called benchmarks because their prices are used as point of reference for traders of other blends, i.e. different types of oil. The other oil benchmark is Dubai Crude.
Crude oil share prices are a representation of the current value of a barrel of oil. Different blends have different prices. WTI has a different price to Brent, for example. At the time of writing, WTI futures were trading at around $52.90, whereas Brent futures were trading around the $55.70 level. The difference between the two is called the Brent WTI Spread.
Prices are affected by many different factors: economic health of countries worldwide; health of manufacturing sectors; global oil demand; outside factors like the Covid-19 pandemic, and so on.
Oil futures vs options
Oil futures are contracts in which an exchange for a set amount of oil to be sold at a set price on a set date is agreed upon.
Demand for oil ebbs and flows, so prices reflect that. As the price per barrel of oil goes up or down, so do the price of crude oil futures. Exporters and importers use futures to insure against any potential adverse effects of oil price volatility. Traders, on the other hand, use futures to speculate on the movement of oil prices without owning, buying or selling oil commodities.
This means they do not have to worry about logistical aspects like transport and storage, nor do they have to sit and wait for the price to increase while their barrel sits in a storage facility. Instead, traders can use futures contracts to take advantage of the same price increase without thinking about the physical logistics of oil.
Options are similar to futures, but with an important distinction. Options give you the right to buy a set amount of oil at a set date for a set price. Unlike futures, however, there is no obligation to buy with options. You can walk away from the trade if you want to.
Where can you trade oil?
The oil benchmarks are listed on exchanges around the world, including the Intercontinental Exchange (ICE) and New York Mercantile Exchange (NYMEX). These are tradeable alongside other hydrocarbon products like natural gas, heating oil, and various types of oil-derived fuels. You can trade the derivatives of these oil futures with a CFD trading account at Markets.com.
Oil spot prices
Crude oil share prices can also be expressed as spot prices. Spot prices represent the cost of buying or selling oil and taking immediate delivery, i.e. on the spot.
A spot price is different to a futures price. Futures show how much the markets think oil will be worth when that future contract expires. Spot prices show much it is worth right now.
Spots and futures haven effect on each other through two important concepts: contango and backwardation.
- Contango – If the spot price is lower than the futures price, then the market is in contango. This is because futures are trading on a premium from the spot price. Physically delivered futures contracts might reach this market state due to factors like storage, financing, and insurance costs impacting oil prices. Futures prices can also change as market participants change their views of the future expected spot price.
- Backwardation – If the spot price is higher than the futures price, then the market is in backwardation. Markets may enter this state if there are currently more advantages to owning the physical product, I.e., keeping oil production high. This is called the convenience yield. It’s an implied return on warehouse inventories (I.e., barrels stored in a warehouse). The convenience yield is inversely related to inventory levels. When warehouse stocks are high, the convenience yield is low and when stocks are low, the yield is high.
Methods of crude oil trading
- Buying futures and options – To trade these, you will likely need access to the right exchange. The top oil exchanges have restrictions in place as to who can actually buy futures and options, so a lot of the time speculation is undertaken via brokers.
- Trading CFDs – Contracts for difference allow you to speculate on the movement of futures and options without owning those assets or any physical oil. You don’t need to be a professional to start trading oil. Instead, simply create an account on our Marketsx platform and you can begin trading CFDs on futures, as well as spots. You could also consider speculating on an oil ETF too.
- Investing – A third option is to invest in oil company shares, either through individual company’s stocks, or through a collection in an ETF. Oil company stock prices are influenced heavily by the crude oil share price, but they can still sometimes offer good value against trading the commodity itself. If you’d like to invest with us, you will need to open a Share Dealing account to use our MarketsI platform.
A word of warning: trading oil, like trading all commodities, contains risk of capital loss. Only trade if you can afford any potential losses.