How to Invest in Oil Futures

The mechanics of trading crude oil futures are relatively simple. If you know how to buy and sell stocks online, you already know the basics of futures trading. However, the unit size is different for each individual futures contract. A crude oil contract represents 1,000 barrels of crude oil. Light Sweet Crude Oil is traded on the New York Mercantile Exchange (NYMEX) between the hours of 9:00 am and 2:30 pm Eastern time, Monday through Friday. The symbol is CL. The contract size is 1,000 barrels. Therefore, for every one dollar of movement in the price of crude oil, the underlying futures contract increases or decreases in value by $1,000.

Difficulty:

Challenging

Instructions

The Basics

1. Open an online futures trading account. The brokerage of your choice will either send you an application package by mail or allow you to fill one out online. The package will include many pages of risk disclosure to ensure that you are aware of the risks inherent in trading futures. The application will also ask for your income, net worth, and any investment experience you have in order to determine if futures trading is an appropriate investment vehicle for you. Once approved, you will be asked to deposit the minimum balance required to open the account.

2. Do your research and analysis. Read the weekly supply/demand report published by the American Petroleum Institute. Consult the available charts. Determine existing supply and anticipated demand, take into account seasonal fluctuations, any weather patterns that may affect oil production or transportation, geopolitical instabilities in oil producing countries, OPEC statements and the crack spread (the relationship between a barrel of crude oil to its products - unleaded gas and heating oil priced in gallons).

3. Conduct technical analysis. Technical analysis includes monitoring increases and decreases in trading volume, candlestick charting, analyzing the moving average price to determine whether short term trends are converging with or diverging from long term trends (MACD), extrapolating Fibonacci numbers, and analyzing the appropriate charts to get a feel for where the market might be going.

4. Deposit the initial margin amount required for the number of crude oil contracts you wish to trade. Check with your futures brokerage for the initial margin requirements, as these fluctuate with the price and volatility of the underlying commodity.

5. Based on the research done in Step 2, decide whether you believe the price of crude oil will rise or fall in the immediate future. This will determine if you will take a long or short position.

Opening The Trade

1. If you believe the price of oil will rise, buy (go long) the number of contracts you wish. For every one dollar the price rises, your contracts will increase in value by $1,000 times the number of contracts you own.

2. If you believe the price of oil will fall, sell (go short) the number of contracts you wish. For every one dollar the price falls, your contracts will increase in value by $1,000 times the number of contracts you own.

3. If you are long and the price of oil decreases, your contracts will decrease in value by $1,000 for every dollar oil drops. If the situation persists, you will be required to add more money (maintenance margin) to your account to maintain the position.

4. If you are short and the price of oil increases, your contracts will decrease in value by $1,000 for every dollar oil rises. If the situation persists, you will be required to add more money (maintenance margin) to your account to maintain the position.

Closing The Trade

1. To close the trade, take the opposite position you took to open the trade. If you went long, sell the contract. If you went short, buy the contract.

2. If you are closing a long position and the price of oil has increased since you bought your contracts, you will be taking a profit equal to 1,000 times the net increase in price times the number of contracts you bought.

3. If you are closing a short position and the price of oil has decreased since you sold your contracts, you will be taking a profit equal to 1,000 times the net decrease in price times the number of contracts you sold.

4. If you are closing your position at a loss because the market moved against you, it is possible that you may lose every penny you invested and then some. Because of the inherent leverage in the trade, your loss could equal several multiples of your initial investment.For example, if you invested $10,000 in initial margin to go long one contract, and the price of oil drops $20 before you close the position, you have lost the entire $10,000 you invested and you now owe an additional $10,000.

Tips & Warnings

• Avoid being motivated by fear or greed. Decide BEFORE the trade where you are going to get in and out.

• Remember -- the pigs get fat and the hogs get slaughtered. If you have achieved your goal profit - TAKE IT!

• Don't average down. Statistically you are better off exiting the position and waiting for a more appropriate entry point.

• The trend is your friend!

• Do not trade crude oil futures unless you are financially and emotionally stable enough to weather the extreme volatility of this market.

• Do not allow a losing position to get out of control. Losses mount very quickly in this market.

• If you are long, your theoretical losses are limited to the total value of the contract if the price of oil dropped to zero.

• If you are short, your theoretical losses are UNLIMITED.

Resources

• NYMEX Contract Specifications
• Lind-Waldock