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Oil Futures Trading 101

Oil Rigs

When contributing to these pages I generally start from the assumption that anybody reading my ramblings is already an active trader, or at least a self directed investor, and therefore understands the basics of trading and investing in the energy markets. A reader recently contacted me, however, and informed me in no uncertain terms that that is not always the case. He said that he had subscribed here to learn about the energy markets and that my arrogance in assuming a certain degree of knowledge had become frustrating. He was nice enough to point out that I had got a few things right during his subscription but the problem was that he really had no idea how to trade the ideas. So, with that reader in mind I thought I would take the time to go over the basics of the way to play a view on oil prices, the futures market.

Assuming that you have a view on the price of oil, the simplest way to profit from that is through futures. Buying and selling physical barrels of oil is obviously not a practical proposition but betting on price fluctuations through futures is as close as you can get.

The market started as a hedging mechanism for both buyers and sellers of commodities, allowing them to lock in a known price for future transactions. The market is traded in “contracts”, each of which represents a specified number of barrels of oil. Contracts have different expiration dates on which physical settlement was originally made. By far the greatest volume of…

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