Among the most popular commodities traded in the commodities markets is crude oil; or what is commonly referred to as the “black gold”.
Previously a preserve for the large intuitional investors, multinationals, central banks, high net worth individuals and hedge funds, crude oil has now become available to small investors too.
This new development has been made possible by the introduction of contract for difference (CFDs) which enables individual average investors to start trading crude oil futures on an online platform through their brokers.
Before you join the market and start trading crude oil, you need to be fully aware of how the market operates in order to maximize your returns and minimize your loses when you get into the market. The most important thing to understand is the demand and supply dynamics that surround crude oil globally.
You also need to have a good grasp of the market forces that trigger different movements in prices of crude oil in the market.
This is very fundamental owing to the fact that when trading in crude oil futures, you are basically trading in a derivatives market where all the principles and guidelines of derivatives trading apply.
A key characteristic of derivatives market is the fact that you actually do not own the underlying asset that you place a trade on; rather, you monitor its price movements and place trades based on your prediction of how the prices of the underlying assets will move in a given period of time.
For instance you can predict that the price of oil per barrel will go up from let’s say $100 to $110 in a given trading day. You then place a trade based on your prediction and agree on the strike price which is the amount you get if your prediction goes right.
At the expiration time for your trade, if your prediction is right you get the pre-determined and agreed up strike price. However, if the odds are against you lose money in the market.
Crude oil demand
Price movements for crude oil are subject to the universal laws of economics of supply and demand. Higher demand for crude oil will result to higher prices for the same commodity if the supply remains constant. On the other hand, a high supply of crude oil with demand remaining constant will result to falling prices for the commodity.
When these prices fluctuate, your trades in the crude oil futures markets are affected; and therefore as a trader you need to have a clear understanding of the forces that cause these price movements.
You should also monitor trends within the market to ensure that you are on track at all times and that any news affecting your commodity is captured in your trading decisions.
Among the top factors that affect demand for crude oil growth of economies which is often tied to industrialization. As economies grow, their demand for oil grows as well since they need the oil to run machinery in their industries.
Economic growth is also associated with a bulging middle class who are known to be the largest spenders on auto mobile; which in the end increase the demand for oil to fuel those vehicles.
Weather patterns also have an effect on demand for oil; with demand in winter being driven by the need for fuel to heat households while in summer more cars are on the road hence fuel demand for the vehicles drives the overall demand for oil.
Another important factor to consider is population growth; the more the people there are in a given country, the more their energy demand and oil just fits in as an easy source of the energy hence pushing up the demand.
Crude oil supply
On the supply side of things, the major factors that affect crude oil supply are geopolitics, exploration costs as well as production costs. The Organization of Petroleum Exporting Countries (OPEC) isa key player in the supply side of crude oil with its 12 member states controlling about 81% of the global crude oil reserves.
Political relationships between the OPEC members and other countries in the world play a critical role in determining how much oil is supplied to the global economy.
The member countries usually work together to set crude oil prices; and determine production levels, which are then adopted in crude oil markets globally.
When we have sanctions on an oil exporting country like we did have sanctions on Iran, the supply in the market tends to go down; conversely, when the sanctions were lifted we are now experiencing a glut in oil supply which is pushing prices further south.
Also when we have wars in the oil producing countries, they cut their production levels and that result in a decline in supply of oil to the global markets.
Such factors need to be at the top of your mind as a crude oil trader in order to figure out where global oil supplies stand compared to the demand for the same commodity; thereby helping you to make an informed decision as to how the prices are likely to move in the future.
Generally, one needs to be very alert to market trends when trading in commodity markets. However, crude oil has its own uniqueness in that its prices are very volatile and therefore demand for even more attention to details than other commodities.
Price movements in oil may sometimes reflect how economies are doing and at times influence fluctuations in the forex markets. It is therefore very important to monitor the demand and supply sides of the black gold keenly in order to fully capture all market indicators in your daily trade.
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