Crude Oil Trading Strategy — What Is It? (Backtest)

Last Updated on August 28, 2022 by Oddmund Groette

Crude oil is one of the different assets you can dabble into as a trader, but the market is quite difficult to master because of the factors that affect it. If you must trade it, you will need to have a crude oil trading strategy.

Crude oil is a naturally occurring, unrefined liquid petroleum that is extracted from the ground and can be refined into various products like gasoline (petrol), kerosene, diesel, lubricants, wax, and other petrochemicals. It is the world economy’s primary energy source, which makes it a very popular commodity to trade. Crude oil trading is the buying and selling of different types of crude oil contracts with the aim of making a profit from the fluctuation of oil prices.

In this post, we take a look at crude oil and how to trade it.

What is crude oil?

Crude oil is a naturally occurring, unrefined liquid petroleum that is extracted from the ground. It was first discovered and developed during the Industrial Revolution, and it is still powering the world’s economy today. Present underneath the earth’s crust, it is typically obtained through drilling, alongside other resources, such as natural gas.

Crude oil has a range of viscosity and can vary in color from black to yellow depending on its hydrocarbon composition. It can be refined into various products like gasoline (petrol), diesel, kerosene, asphalt, lubricants, wax, and other petrochemicals. These products are used to fuel our automobiles, aircraft, and various industries, including cosmetics, fabrics, and pharmaceuticals.

As the world economy’s primary energy source, crude oil is one of the most actively traded commodities in the world. Crude oil is a nonrenewable resource; it can’t be replaced naturally at the rate we consume it. So, it is available in a limited supply, which is why the demand is high, creating massive price fluctuations that traders try to profit from.

Dubbed the “black gold”, crude oil is a popular commodity, and its demand often sparks political unrest because a small number of countries, especially in the Middle East, control the largest reservoirs. Saudi Arabia, Russia, and the US are the leading producers of oil in the world. The supply/demand dynamics and the resultant massive price fluctuations make crude oil trading popular among commodity traders.

There are many different types of crude oil traded on the global market, but only two primary types serve as global benchmarks for crude oil prices. They are:

  1. Brent Crude Oil: This is gotten from oil fields in the North Sea. It is characterized as a “light and sweet” oil, although it is not as “sweet” or “light” as WTI. Brent Crude Oil constitutes about two-thirds of global crude oil contract trades.
  2. WTI Crude Oil: West Texas Intermediate (WTI), as the name suggests, is gotten from US oil fields primarily in Texas, Louisiana, and North Dakota. It is referred to as ‘light sweet crude oil’ due to its low density and low sulfur content, which make it less expensive to produce and easier to refine than ‘heavy’ or ‘sour’ oils. It is the main benchmark for oil consumed in the US.

Is crude oil good for trading?

As with other commodities, crude oil contracts are traded for speculative purposes — to profit from the fluctuation in oil prices. But for a retail trader with limited analysis capabilities, is crude oil good for trading? Well, we don’t think so. We believe crude oil is difficult for trading because it’s influenced by a lot of macro news that is nearly impossible to track or forecast.

Besides, there is no tailwind like in stocks, which can go up in the long run. Crude oil prices have no general direction. In fact, price changes are often associated with world politics. A cough by the Saudi Arabian crowned prince could send crude prices soaring or plummeting, let alone a phone call between Saudi and Russia. The same can be said of OPEC meetings, US sanctions on some countries like Iran, trade wars, and Middle Eastern geopolitical crises.

There are just too many variables at play that can move the prices of crude oil, which you may not be able to track as an individual trader. The demand and supply dynamics are too politically motivated to be predictable. So, given the unpredictable volatility and factors affecting the market, crude oil trading can be very risky for a retail trader with limited resources.

Where can you trade crude oil?

There are different ways you can gain exposure to the crude oil market, including futures, options, stocks, ETFs, and CFDs.

  • Futures: Crude oil futures are contracts to exchange an amount of oil at a set price on a set date. Oil futures are a common method of buying and selling oil, and they enable you to trade rising and falling prices. You can trade futures contracts of any of the two types of crude oil (Brent or WTI) on a commodity futures exchange, such as the Intercontinental Exchange (ICE), New York Mercantile Exchange (NYMEX), and the CME Group’s Globex platform. You can access the exchange by opening an account via a futures broker.
  • Options: Crude oil options contracts give you the right to buy or sell an amount of oil at a set price (strike price) on or before a specified expiry date, but you wouldn’t be obliged to exercise your option. Options contracts are also traded on futures exchanges, and you would need to open an account with a broker to have access to the market. There are two types of options contracts: call options and put options. You buy a call if you think the prices would rise and buy put if you think prices would fall.
  • Stocks: You can gain exposure to the crude oil market by trading stocks of companies that are involved in crude oil exploration, refining, and marketing. Stocks are traded on stock exchanges, and to trade them, you have to open an account with a stockbroker.
  • ETFs: Another way to gain exposure to the crude oil market is to trade ETFs, which are a collection of crude oil stocks. There are crude oil ETFs that invest in crude oil futures or track the futures prices. You can buy and sell crude oil ETFs in the same way you do stocks in the stock market. When the price of oil fluctuates, it affects the share prices of crude oil stocks and, subsequently, the value of the ETF.
  • CFDs: Crude oil CFDs (contracts for difference) are contracts with an online broker to exchange the difference in the price of crude oil contracts between the time you open a trade and the time you close it. To trade crude oil CFDs, you have to open an account with a CFD broker. This is the easiest way to trade crude oil, as you do not have to worry about asset delivery associated with futures trading.

What is the best strategy for trading crude oil?

There is no best strategy for trading crude oil, but we believe that trading based on seasonality is the best approach. Seasonality refers to noticeable patterns in the price movement of an asset during certain times of the season. Since crude oil is refined into gasoline and distillate, the seasonal trends in crude inventories are in line with the demand for gas and distillate. Seasonal peaks usually appear in April, May, and November, while troughs appear in January and September.

In addition, analyzing macroeconomic events that happen around the world and how they might affect the crude oil market is the only way to stand a chance of making profits from crude oil trading.

Crude oil trading strategy (backtest and example)

A backtest of a crude oil trading strategy is coming soon.

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