Trading oil futures is an attractive proposition to many people. The market moves quickly, and in both directions, giving lots of opportunity for profit. Of course, that also brings the risk of losses but most of the time, the oil futures market is liquid enough to allow for good order fills on both entry and exit orders. For those whose only trading experience is in stocks, however, getting involved in oil futures can be a daunting experience. Those looking to do so always have questions, and there are some things you need to know if you want to get involved. Here are the answers to the questions most people have when they set out.
What Are Futures?
A futures contract is an agreement to buy or sell something at a set price on a given day in the future. So, when you trade oil futures, you are agreeing to buy or sell a set number of barrels of oil. That number varies according to the type of contract you trade. The standard WTI oil futures contract, ticker symbol CL, represents 1000 barrels, for example, and the E-Mini contract, QM, represents half that.
Obviously, most traders cannot deliver or take delivery of that many barrels of oil, so most traded contracts are non-deliverable. They are settled financially at their expiration date with a debit or credit in the trader’s account.
Futures are set to be settled every month on a day set by the exchange. For CL, that is usually on the 21st to 24th of the month prior to the month named in the contract. Thus, the last trades in the April 2023 CL contract, for example, are set for March 21st, 2023. The contract that most people trade is what is known as the “front end”, the closest to settlement at the time of trading, although you can also trade futures that won’t be settled for many months, or even years.
Can Anyone Trade Oil Futures?
No. You have to open an account that allows you to do so and, in the US, there are restrictions as to who can open a futures trading account. You have to be what is called an “accredited investor”, meaning that you have to have trading experience, and/or show that you have a net worth above a certain amount. Even if you are not located in an area where the law requires that, you may well find that reputable trading platforms voluntarily impose those or similar restrictions.
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The reason is that, as mentioned, while futures allow for big profits, there is a flip side to that…losses can pile up quickly. That means that in the eyes of the regulators, only people that understand that or for whom a loss probably won’t be life-changing should get involved.
How Much Money do You Need to Trade Oil Futures?
There is, in most cases, no legal, preset minimum amount that must be used to fund a futures trading account, although many brokers and trading platforms do have their own minimums. You should research different brokers to find one whose minimum suits your resources. At the very least, though, you have to have enough to cover what is known as the “margin” to begin trading.
What Are Margins?
The margin is a kind of deposit required by exchanges to trade futures. There are two types of margin, the opening margin, and the maintenance margin. The first is the amount that will be deducted from your account when you first open a position, the second is a minimum “deposit” balance that must be maintained. The margin assures the exchange that you will have enough money to pay for losses, so if the position goes against you, you will often get a “margin call”, a request for more money. If you don’t meet that, the exchange will close out your position and debit your account to cover your losses.
What Types of Positions Can You Take in Futures?
There are two basic positions in oil futures, as in all trading, long and short. A long position is when you buy the contract and you benefit should the traded price go up. Short is the opposite, where you sell it and make money if it goes down. It is important to understand that, unlike with stock trading, you don’t have to “borrow” oil to sell it short. You simply sell the futures and, hopefully, watch the price drop!
What Should I Consider When Trading Oil Futures?
In many ways, this is the toughest question beginners ask, because there is no one set, correct answer. Oil moves based on supply and demand, with multiple factors affecting each side of the equation.
At a bare minimum, though, before you start to trade oil you should be aware of the global economic situation and prospects, and of any geopolitical circumstances that may affect supply, including the views of OPEC. Then there is technical analysis, the study of charts. In the short-term oil futures tend to be quite sensitive to technical factors, so at least a basic understanding of support, resistance, and other common technical analyses is required.
What Advice Would You Give to New Oil Futures Traders?
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First, start small. I would definitely recommend that you start with the Micro E-Mini contract that represents only 100 barrels, one tenth of the main contract. That means that margin requirements are lower, and moves in the price of oil make for smaller profits, but also smaller losses. It takes time to get a “feel” for the futures market, so don’t risk too much straight away.
Second, understand that the volatility of oil futures makes losses a possibility, even in the best thought out, most logical positions, and the leverage involved in trading multiple barrels with only a margin payment required means that losses can quickly accrue. That means that you have to be disciplined about cutting losing positions. You can always rethink and renter a position, but avoid taking too big a loss on an open one.
Trading oil futures can be both exciting and rewarding, but it is not for the faint of heart. You will need to do extensive research to do it well, and will need to monitor open positions constantly, so it is not something to undertake half-heartedly. If you understand that, though, and all of the things explained above, you can get involved if you have the resources.
Good luck!
By Editorial Department
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