US oil prices turned negative for the first time in history this week. The crash in prices would be felt by countries and oil companies that heavily rely on oil for the lion share of their income. Countries such as Nigeria that depends on oil revenue to finance her budgets are deeply affected by this declining oil prices.
The effect of low prices has a negative impact on the Nigerian economy, which inadvertently affects her citizens. Already, we have witnessed, the value of the naira depreciates to the dollar and other global currencies—no guesses what this would mean in the business and economic environment.
However, you can hedge yourself from your country’s economic misfortunes by personally profiting from the oil market volatility. This article is for people who are interested in investing in the oil markets. If you’re thinking of oil investing, you’re definitely not alone. A lot of people have made a few inquiries on how to invest in the energy market. Well, there are several ways to go about this, from indirect exposure through an energy-related stock or direct trading and speculation of oil futures in the commodity market.
Firstly, let me drop a brief overview of the commodities markets. The commodity markets involve the buying and selling of commodity instruments in the form of derivatives, options, or futures in both international and national marketplaces for the objective of making a profit. Oil is the most traded commodity worldwide. However, there are other commodities traded, such as gold, cotton, soybeans, wheat, cattle, pork bellies, and sugar. Yes! People trade soybeans. The prices of these commodities are fundamentally based on their demand and supply. In the past, large corporations have been the main participants in the commodities market. However, many retail investors now have access to this market via the internet.
So how then do we trade oil?
There are several ways of trading oil. You can trade oil by trading oil futures, trading oil CFDs, trading oil ETFs, trading oil MLPs or investing in oil shares. For this article, I would talk about the popular way to invest in oil with little money, which is trading oil CFDs. CFDs stands for Contracts for difference. This involves speculating on the oil price difference between the opening and closing of the trade; you do not physically buy oil itself. As a trader, you can take positions based on economic trends or exploiting opportunities in the oil markets.
In the oil markets, thousands of companies, retail investors, institutions, and even governments, such as the Mexican government, are all trying to profit from buying and selling oil instruments at the same time. This creates enough liquidity in the market, and prices of these instruments continuously move. A market that moves a lot is known as a volatile market. Market participants often failed to take full advantage of crude oil fluctuations either because they have not understood the dynamics of all these markets. These markets bring more opportunities for profit, but also mean increased risk.
The oil market can be dicey to both the professional and retail investors, with significant price fluctuation occurring daily. Several forces are driving the oil market, and one of the strategies traders use in this market is called arbitrage.
Arbitrage is the purchase and sale of an asset in order to profit from a difference in the asset’s price between markets. It is a trading strategy that profits by exploiting the price differences of commodities.
Numerically speaking, if you speculate that the price of oil would drop from $10 to $9.90. you can make money for every cent drop from $10 to $9.90. The difference between $10 to $9.90 is 10 cents, so if you trade with a dollar account and open a position size of $1, you will profit $10 from that movement, which could occur in a few minutes. Looks simple right?
So if you traded US oil on Monday using a $1 position size, and sold at $18.35 (which was the market’s opening price) to the historic ‘$0” it traded to, you would have made $1,835 on Monday. (note, this does not account for spreads and commissions issued by your broker) However, you have to note; you can lose money if the price goes in the reverse direction of your prediction/speculation.
Trading in the oil and energy markets requires a certain degree of skill to profit from oil price fluctuations.