If you want to diversify your investment portfolio, you probably have considered oil trading. Investing in oil offers several advantages. It’s easily accessible because you don’t need to physically own the commodity before trading it. Moreover, it can act as a hedge, spreading out and balancing risks in your investment mix. This makes your overall portfolio safer and more diverse.
According to the Energy Information Administration (EIA), oil prices will appear stable in the long run. Hovering around 2023 figures, Brent crude oil could average $82 per barrel in 2024 and $79 in 2025. The trajectory will be the same for West Texas Intermediate (WTI). As for oil supply, the International Energy Agency (IEA) forecasts a significant increase, hitting 103.8 million barrels per day in 2024. It will be mainly driven by non-OPEC+ nations.
If you want to try buying and investing in crude oil, this article will give you the basics.
First, what is crude oil?
Crude oil, one of the most important commodities globally, is an unrefined petroleum extracted from the earth. This is the most common type of oil that traders buy and sell in the market. Crude oil can be further classified into different kinds, depending on its makeup and source. Here are three major types:
- Brent crude oil. Extracted from oil fields in the North Sea, Brent crude oil is a widely traded and benchmarked type of crude oil. It has low sulfur content and high API gravity (This refers to how light or heavy an oil is compared to water). Brent is the leading global price benchmark for Atlantic basin crude oils and is preferred for its ease of transportation.
- West Texas Intermediate (WTI). WTI comes from oil fields in Texas and nearby regions. Since the areas where it is extracted are landlocked, transportation costs for WTI are relatively high compared to Brent. But like Brent, it has high API gravity and low sulfur content. WTI is a key pricing reference for crude oil in North America.
- Dubai crude. This medium-grade crude oil is mainly sourced from the Middle East. With a higher sulfur content and lower API gravity than Brent and WTI, Dubai crude is frequently referenced for pricing Middle Eastern and Asian crude oil grades.
The volatility of oil prices
One disadvantage of oil trading is how volatile oil prices can be. Though volatility can open up opportunities for profit, it also brings higher risks. And the latter can cause unexpected, substantial losses.
Hence, keeping a close eye on price movements is important to manage these risks effectively.
One major factor affecting oil prices is the state of the economy. When the economy is struggling, the demand for the commodity dampens, causing prices to dip. On the other hand, an improving economy can boost demand and lead to oil prices.
Since oil is trading in U.S. dollars, how the currency performs also impacts oil prices. A strong dollar can lower prices, while a weak dollar can raise them.
Global oil production is another thing to consider. In a nutshell, oil prices drop when production increases and rise when the supply is cut. Other exogenous shocks, such as geopolitical instability and natural disasters can also disrupt oil production. This could drive oil prices upward, as demand will increase, with consumers undertaking panic buying.
Read more: How to invest in gold in the UAE
Ways to invest in oil
There are different ways you can invest in crude oil. Here are three main types of oil investments you can make.
Oil stocks
Some of the biggest companies in the world are involved in oil. And investing in oil stocks means owning shares of publicly listed firms engaged in petroleum extraction and production. This option can yield substantial gains through both share price appreciation and dividends, especially when oil and gas prices are high. As crude oil prices climb, oil companies often experience a surge in cash flow. This enables them to expand drilling operations, reduce debt, buy back shares and distribute dividends.
Oil funds
Oil funds, including exchange-traded funds (ETFs) and index funds, offer a convenient way to invest in a basket of oil-related stocks in one go. However, solely investing in oil funds may limit your overall diversification efforts, as they exclusively focus on the oil industry. In the event of a downturn in the sector, an oil fund may underperform a more diversified fund. On the upside, if you supplement a portfolio that already contains broad funds with an oil ETF or index fund, you can balance risks.
Oil futures
Trading in futures is more complex than investing in oil stocks or funds. Unlike stocks or funds, futures trading involves dealing with contracts rather than physical commodities. Contracts specify the amount of oil to be exchanged at a predetermined price and date. This means that a rise in oil prices may increase the value of the contract, allowing for potential profit upon sale, while a decrease could lead to losses when selling.
How to get started with oil trading
If you understand the risks that come with trading oil, the next question is: How do you start investing? Here’s a quick guide.
Step 1: Research and choose a reputable broker
Like other forms of investing, your oil trading journey begins with exploring various online brokers that offer such services. When selecting a broker, look into what clients have to say and check if they’re compliant with regulations. Also, evaluate based on user-friendliness of the platform, fee structure, and availability of the specific oil market products you want to trade.
Step 2: Register and verify your account
Once you’ve chosen a broker, you may now start the actual account registration process. Expect to provide identification and residency documentation. This is part of standard security and regulatory procedures. Apart from that, you may also be asked about your trading experience.
Step 3: Deposit funds into your account
After your account is approved, fund it with sufficient funds for trading. Brokers generally offer several deposit methods, such as bank transfers, credit/debit cards, and online payment options. Always check if there are any minimum deposit requirements.
Step 4: Familiarize yourself with the trading platform
Take the time to acquaint yourself with the broker’s trading platform and its features, including charts and analysis tools. If you don’t want to risk real funds, consider utilizing demo accounts that let you practice trading and develop your strategies. While at it, conduct thorough market analysis. Stay informed about oil price trends and updates.
Step 5: Begin trading and monitor consistently
Now armed with sufficient information, you can select the oil market or instrument you want to invest in. Choose the appropriate order type and quantity. As a tip, make sure you set stop-loss and take-profit levels to manage risks effectively. After that, regularly monitor your trades, keeping an eye on oil price movements and market developments. Always evaluate your trade outcomes and keep learning.
Final thoughts
Oil trading offers numerous advantages, including accessibility and diverse trading opportunities. These are bolstered by 24/5 market access and various risk management tools available.
However, like other investments, it comes with risks. Understand that oil is volatile and it can lead to huge losses. Buying and investing in oil also demands complex market analysis. Remember the golden rules of trading: Diversify and don’t invest money you can’t afford to lose.
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