At the beginning of 2020, oil quotations set an anti-record of minus 40 USD per barrel. However, this did not scare traders away; on the contrary, they kept buying oil, waiting for a bounce. Oil did not spend much time near zero and headed upwards quite soon. As for now, a barrel of Brent price is 48 USD per barrel.
There are a few reasons for oil to drop so steeply; the most frequent ones are financial crises. However, step by step world economies come back to normal, the demand for oil increases, and oil prices aim high.
To trade oil successfully, you need to study the market and all the factors that influence the quotations. Do not forget graphic analysis with the use of indicators and price patterns. When oil drops again and will be ready for a reversal, take long positions and hope for a soon bounce followed by a long-term uptrend.
How does the oil market work?
Oil influences the world economy more than significantly. The prices show if there is a crisis, or the economy develops stably. In the latter case, all manufacturers need oil to produce goods. Oil is supposed to be the most sold commodity in the world. Contracts for oil, in their turn, are the most popular trading instruments.
Industrial production generates the largest part of the oil demand. If industry and production grow, oil prices will follow up because the oil demand will be increasing. If industry slumps, as nowadays during the pandemics and constant lock-downs, the demand for oil falls, and so does the price.
If you want to enlarge your crude oil trading skills, check out our “Crude Oil Trading Strategy” article
Crude Oil types
Investors prefer such oil types as WTI and Brent. The latter is the standard. It is produced in the North sea and mostly sold to Europe and Asia. Traders say that Brent futures are the most popular ones in the world.
The WTI oil is produced in Texas and sold in the West hemisphere. This oil type normally presumes real supply. Hence, the decline to minus 40 USS per barrel at the beginning of this year. The main difference between the two types is their density and the concentration of sulfur.
Futures are contracts to be executed in the future, either buying or selling ones. If an investor buys an oil futures, they become the owner of the oil until the trade closes. In reality, futures are used for making a profit and do not require real supplies of oil. Traders use futures in special exchanges only, trading lots; one lot normally equals 10 barrels of oil.
Some think that it is more difficult to trade options: we do not only need to guess where the market will go but also estimate the time that it might need to reach its goals. Also, we may not close an option before its trade expires. A trader in advance buys an option above or below the current price for a certain period.
This type of trading is thought to be meant for traders with small capitals who can trade short-time and make quick profits. We can use minimal trade volumes, especially compared to futures.
An ETF might be called a portfolio constructed by a large trust from assets of one sector. The trust charges a commission fee for servicing and holding an ETF.
Traders single out several groups in oil ETFs. Firstly, ETFs are directly connected to oil prices: a trust might simply buy oil futures. The second group includes energy companies that produce, deliver, and sell oil to the final consumer. The third group is comprised of oil-producing companies that either just produce or process oil.
For more about ETF, check out ETF Beginners Guide
What do oil prices depend on?
Firstly, turbulence in oil-producing countries.
As long as oil-producing companies are the main sellers, political stabilities in the corresponding countries might influence oil quotations noticeably. Instability can lead to a decrease in supply or a total absence of them. In such cases, the supply of oil in the world drops, and prices may grow.
Secondly, OPEC quotas for oil production
For example, OPEC can decrease the quota for oil production, which will also take the supply down, and if the demand remains as before or grows, the prices will inevitably grow.
Thirdly, the EIA information
If the amount of crude oil in the USA grows, oil prices fall, as we have seen during the pandemics. The consumption of oil was minimal, and storages were overflowing, which in the end made the quotations slump.
Fourthly, climate, and seasonal factors.
It is supposed that during hurricanes in the USA oil prices might grow — again because the supply might interrupt. In winter, when people need heating, oil prices may also go up. If the winter is warm, and the temperature holds above zero Celcius, oil consumption remains minimal.
Finally, the development of the world economy.
The more actively the world economy develops, the higher is the oil demand. However, during lock-downs, sales dropped in oil spheres. In such a situation, oil prices will fall, but as soon as the economy starts recovering, oil prices will follow because the economy needs oil.
Make sure to check out our post “How to Make Money on Oil?”
Oil contracts are a popular trading instrument all over the world. As we can see, oil prices depend on the state of the world economy. Political turbulence in oil-producing countries also makes oil prices fluctuate. Even a hurricane in the USA can drag oil prices to new highs, while pandemics can drop them.
However, even a beginner can make money here. It is clear that oil prices do not fall under zero and stay there long. Anyway, study the factors of influence and train to trade them to be ready to buy oil at its lowest at the next decline.
By Dmitriy Gurkovskiy, Chief Analyst at RoboForex