May 25, 2023
Oil is a major energy commodity that is relied on globally to produce gasoline, diesel and petrochemicals that power much of the world’s activities. Like all hard commodities, it’s a raw material on which much of the global economy relies — in fact, it’s the most commonly traded commodity in the world. That volume of trading has created many derivative financial products, including oil CFDs.
The oil and gas industry
There are different types of oil that are traded internationally: crude oil, no lead gasoline, natural gas and heating oils. While some of these oils tend to be traded more locally, crude oil remains the largest of these sectors in terms of trade and is sourced from different points of origin around the world. The volume of crude oil trading and its varied points of origin mean that this asset is particularly vulnerable to geographic, political and economic instability, all of which make the market particularly volatile.
Volatility in markets spells both risk and opportunity for traders because they increase the size and frequency of price fluctuations. If you want to gain exposure to the oil market and potentially capitalise on some of the profitable opportunities yourself, learning how to trade oil CFDs could be a good method to do so.
In this article, we’ll define what oil CFDs are, how they fit into the oil market and what you’ll need to know before you start trading oil CFDs as an individual trader.
Understanding how oil CFDs work
CFDs are a type of derivative financial product that allows traders to get exposure to a market like oil trading without having to take possession of an underlying asset. CFD trading works by creating an agreement between an investor and a CFD broker — or more simply a buyer and seller — to exchange the difference in value of the underlying asset between the opening and closing of the contract.
Unlike buying or selling the physical asset, oil CFDs (and any kind of CFDs) don’t deal with the buying and selling of a commodity; they make traders profits through the speculation on the changes in price of the asset. The changes are what generate profit or loss in this situation. Successfully trading CFDs requires a trader to understand the reasons and trends behind movements in the market, in order to successfully predict what moves will play out during a CFDs duration.
What are oil CFDs?
Essentially, oil CFDs allow more traders to gain exposure to the large oil market through the use of leverage and without taking possession of the asset itself. This increased exposure can diversify your investment portfolio and, in doing so, lower your risk. Oil CFDs are used as a conduit for investors to trade in oil spot prices, oil futures and oil options. As the most commonly traded benchmarks of crude oil, most oil CFDs are concerned with WTI or Brent Crude Oil.
WTI vs Brent Crude Oil prices
If you want to get into trading oil CFDs, it’s almost certain that you’ll be dealing with the two most common types of crude oil in the global market: West Texas Intermediate (or WTI) Crude Oil and Brent Crude Oil. Crude oils are rated for their density and their ‘sweetness’ or ‘sourness’ when it comes to assessing quality. Low density crude oils are preferred because they are easier to process and refine, while sweetness refers to the sulphur content in a given crude oil. The sweeter the oil, the lower the sulphuric content, which also makes refinement and processing cheaper.
Understanding the key differences between these two and their defining features is a crucial part of fundamental analysis — something you’ll need to be across when trading oil CFDs. At a glance, here’s a snapshot of both types of crude.
Brent Crude Oil
- Sourced from oil drilling in the North Sea
- Responsible for setting the price of two-thirds of the world’s traded crude oil supplies
- Defined as a light crude oil, but not as light as WTI Crude Oil
- Typically refined in Northwest Europe
- Brent Crude Oil CFDs are traded over a five-day work week
- Brent can be particularly vulnerable to crises and instability because it is relatively more widespread
WTI Crude Oil
- Sourced from land based oil fields in Texas, Louisiana and North Dakota
- One of the two main benchmarks for pricing of global oil markets, along with Brent Crude
- Graded as ‘Texas light sweet’ oil, both lighter and sweeter than Brent Crude
- Typically refined in Texas and Oklahoma
- Land-based drilling can make shipping and transport of WTI Crude Oil more expensive
- International events and instability have less of an effect on price
- Traded on the New York Mercantile Exchange (NYMEX)
Now that you have a basis for fundamental analysis of these crude oil markets, you can continue to study these external factors, as well as the price charts and indicators that make up the technical analysis of a market. Trading in oil CFDs requires you to have a good grasp of fundamental and technical analysis in order to ride out the volatile movements of the market.
How to trade oil CFDs
As we’ve mentioned, learning how to trade oil CFDs means learning how to engage in leveraged trading. All oil CFDs have a margin rate, and leveraged trading means that you trade on this margin, rather than the full value of the asset. Keeping control of your leverage and having a risk management plan are essential when trading oil CFDs.
In order to start trading oil CFDs, you’ll need to follow a few steps:
- Familiarise yourself with live trading. Decide whether you want to trade oil CFDs for Brent Crude Oil, WTI Crude Oil or both. Once you’ve made your choice, you can open a demo account and start practising by monitoring the trading tools and indicators within the trading platform and opening and closing oil CFD trades in a risk-free environment.
- Create your oil CFD trading account. When you’ve managed your demo account for a while and feel comfortable with the trading environment, you’re ready to jump in by creating a live trading account, downloading the trading platform and depositing funds.
- Manage your risk. With your trading markets decided on and your account created, your next step is to establish your risk management tools and strategies, so you don’t end up with more losses than you can deal with.
We recommend using stop-loss orders and limit-close orders — these tools will automatically close your position if it dips below an acceptable loss threshold you’ve set up.
- Study the market. Analysing the oil market and making correct predictions about the movement of oil’s price will take more than a brief overview of the fundamentals. You’ll need to research both fundamental analysis and technical analysis in depth, keep an eye on breaking news and watch trending performance over time in order to recognise patterns.
Successfully trading oil CFDs will require you to understand both the data behind market movements and the broader social, political and economic context in which they operate.
- Formulate a strategy. Do you want to open and close positions on a short-term basis or ride out a trading strategy with a longer-term plan? There are lots of strategies for both long and short-term oil CFD trading, so be sure to decide on one that suits your portfolio and goals and implement it properly.
- Think about diversification. Oil CFDs are part of a larger puzzle that fits together with other pieces to create a portfolio that is diversified and has lower overall risk. If you want to trade energies like natural gas, no lead gasoline and heating oil along with crude oil, VT Markets has the advice to get you started.
Interested in other methods of oil trading? Check out our in-depth guide on how to trade oil.
Trading oil CFD futures
One of the other benefits of oil CFDs is that they allow you to trade oil CFD futures. Futures are agreements between two parties to exchange an asset at a fixed price on a nominated date in the future. Whereas oil futures are traded on local exchanges, oil CFD futures give you as an investor the opportunity to trade on the price movements of these future contracts in the form of an over-the-counter product.
The pros and cons of trading oil CFDs
As with any trading method, oil CFDs have their own advantages and disadvantages, which you’ll need to weigh up before you get started.
Pros
- Trading oil CFDs requires you to trade with leverage, which means traders only have to place a percentage margin of the full trade value as a deposit. This can give you increased exposure in oil markets and has the potential to maximise your profits.
- Oil CFDs give you the chance to gain full exposure to the oil market without needing to take possession of any physical assets.
- Trading oil CFDs can be thrilling for investors who want to challenge themselves in volatile markets.
- This volatility also opens up more potential opportunities for traders to make a profit.
Cons
- It’s worth noting that oil CFD trading is not permitted in the US and is taxed, unlike other methods such as crude oil spread betting.
- Leveraged trading can maximise your profits, but it can also amplify your losses. You should bear this in mind and have a strategy in place for mitigating the risks involved with trading oil CFDs.
- The oil market is volatile and requires close monitoring as well as detailed knowledge of your chosen market if you want to trade oil CFDs.
Learn how to trade oil CFDs with VT Markets
Learning how to trade oil CFDs definitely takes practice and familiarity with volatile global oil markets. Fortunately, with VT Markets’ demo trading accounts, you can become more confident opening and closing your position in an environment that mimics the experience of a live trading environment.
We use powerful platforms MetaTrader 4 and MetaTrader 5 to provide our clients with an easy-to-navigate, transparent trading platform that can be downloaded to your computer or mobile device for simple market monitoring. As well as lightning-fast order execution and restriction-free trading, we offer our clients state-of-the-art trading tools and market analysis to give them the insights they need to trade oil CFDs.
Want to jump into oil CFD trading but not sure where to start? Talk to us today about starting to develop your trading style with the help of our platform.
