Crude oil is one of the most popular commodities in the market today. Traders love it because of the vast amount of information that is available. They also love it because of its high volatility and liquidity. This liquidity comes in the form of the amount of oil that is traded every day.According to the International Energy Agency (IEA), the world consumes about 91.7 million barrels of oil every day. At the current price, that translates to more than $3.8 billion. In this report, we will look at some of the most popular oil trading strategies.
Arbitrage trading strategy is based on the concept of correlation – which simply means relationships between two items. In the market, you can use this concept to trade two assets that have a close relationship and those that have an inverse relationship. In crude oil, you can play this strategy by buying one benchmark – say Brent – and shorting another the other one. The strategy works well because the two benchmarks usually move in the same direction, as shown in the chart below.
Therefore, in crude oil arbitrage, you can buy one benchmark and simultaneously short the other one. If the price rises, you will make money from the first trade while losing money from the other one. As such, your profit will be the spread or difference between the two.
Arbitrage is a concept used in other assets also. For example, merger arbitrage is used by event-driven hedge funds when they invest in the company being acquired while shorting the acquirer. It is also used in currency arbitrage.
Price action strategy
Another oil trading strategy as found on Invezz is known as price action. This approach involves looking at charts and identifying the patterns. These patterns could be the overall chart patterns like triangles, wedges, head and shoulders, and cup and handle. They can also be candlestick patterns like bullish and bearish engulfing, hammer and shooting star. These are the same patterns that are used in trading other assets.
For example, a wedge pattern is a reversal pattern that happens when an asset’s rally starts losing steam. A rising wedge is usually a sign that the price will reverse lower while a falling wedge is a bullish pattern. For example, the chart below shows that West Texas Intermediate (WTI) was forming a rising wedge pattern that ended in a downward reversal.
Bullish flags and pennants are also popular patterns that you can use when trading oil. These two are continuation patterns that happen when the price is rallying. Pennants are shaped like a triangle while a flag is made up of parallel lines of support and resistance. When the two happen, it usually sends a signal to buy, as shown in the chart below.
Technical analysis is a trading strategy that uses indicators to identify buying and selling opportunities. These indicators are created using mathematical calculations. In most cases, the indicators can help you identify buying and selling opportunities. In other cases, they can help you find places to add your take profit and stop loss. Others can help you identify extreme levels in the market.
There are hundreds of indicators used by traders today. They include moving averages, Bollinger bands, Donchian channels, the Relative Strength Index (RSI), and the Money Flow Index (MFI). In the chart below, we see a Donchian channel applied on Brent crude oil chart. While the indicator does not tell you exactly where you should short/sell, it tells can guide you on where a reversal is about to happen. When the price is falling, it is usually along the lower line of the indicator. A reversal happens when the price crosses the middle line of the channel.
Fundamental trading is another crude oil trading strategy you can use. This approach involves looking at the key supply and demand data and making decisions from them. It is also useful to traders with a long-term horizon like weeks, months, and even years. The idea is to analyse the current information and predict where the price will move to.
For example, you can use data from the organisation of oil-producing countries (OPEC), Energy Information Administration (EIA), and the International Energy Agency (IEA) to predict the future demand and supply. You can also follow the news on OPEC supply cuts and boosts and other valuation metrics to identify key entry points.
Trading crude oil can be a profitable and highly-fulfilling exercise. Indeed, many people have made a fortune by specialising in crude oil trading while ignoring other sectors like stocks, indices, and currencies. Still, trading in oil is also a risky exercise, which means that you should spend a lot of time learning and backtesting your trading strategy. You should also apply risk management approaches like volume control and using stop-loss tools.