Investors are told over and over again to diversify their holdings. That they shouldn’t have all their investments in one area. They should own some real estate, some stocks, some bonds, some mutual funds and some commodities. These can range from gold and silver to oil and gas and everything in between those groups. Learning how to master investing in commodities takes time. Before you waste your money, you need to consider the problems that can occur from investing in oil or other commodities. To help you in this regard, given below is everything you need to know about oil trading.
How Do You Start to Trade in Oil?
You have to learn about the commodity before you can start oil trading. Crude oil is a naturally occurring substance that is found in rocky areas around the world. It is processed and sold in barrels. As a commodities investor, you have several options: energy-related mutual funds, oil companies, oil futures, exchange-traded funds or notes, or straight commodities.
Energy-Related Mutual Funds
These are mutual funds that invest in stocks of a number of energy companies, including oil firms. When advances are made in energy, the companies’ stocks increase. When problems hit energy companies, the prices of the stocks decrease. Overall, the mutual fund has many options for company stocks, which protects investors from losing it all from one company.
Oil Company Stocks
You can buy stocks directly without going through a mutual fund in companies that drill for oil, process oil, sell oil or petroleum, or is engaged in oil as a product in some way. Putting all your money in one company can be risky, though. The stock prices could fluctuate based on the problems associated with oil. For example, the oil companies are experiencing low barrelprices and less profits right now due to several issues, including production problems. And, the stock prices are following right along.
When you invest in futures, you are signing a monthly contract that you will buy or sell oil at a predetermined price in the future. These contracts are usually set at 1,000 barrels, which means that even a fluctuation of 1 cent equals a profit or loss of ten dollars per barrel. You are hedging your bets that you can pay a certain price now either to buy it or to sell it, and that the commodity will skyrocket in the future or that it could drop considerably in the future. This is a risky investment but provides big gains when it works well.
Exchange-traded Funds or Notes
These are like the energy-related mutual funds but are dependent upon how well a market index does. It’s a type of debt security that is not like bonds or notes. No principal exists for this investment.
You also can purchase the oil directly and sell it. That is owning straight commodity, such as buying gold bars. In this case, you would own the barrels. This type of commodity investment isn’t easy to do.
Once you pick the type of investment you want to make, you have to consider these issues that affect your investment.
Supply and Demand
The Organization of Petroleum Exporting Countries (OPEC) controls oil supply for the most part. When it increases the price per barrel, supply drops and demand and price skyrocket. When it decreases the price per barrel, more supply floods the market. Although demand might remain the same, the extra supply means the prices drop. Your investment is tied to what OPEC decides to do with the supply. Emerging countries also affect supply and demand because they offer subsidies that can force an increase in production, which, in turn, increases prices and makes your investment rise.
Much of the oil is housed in volatile countries where political unrest is a daily occurrence. When coups or political events in these countries happen, it affects supply and demand. For example, a war in a particular area of the world could cause barrels of oil to catch fire and shorten supply. Or OPEC could hold production as ransom for something the countries want in return, also shortening supply. OPEC also can increase production when it doesn’t help other countries and flood the market, which would lower prices.
Issues on Foreign Exchanges
Often, you have to buy and sell oil on foreign exchanges, or “Forex”. However, foreign exchanges have their own rules about investing in oil. You have to understand the rules before you begin investing or trading in oil online.
After you evaluate what you want to purchase and consider these things that can influence prices, you will be able to make a great investment in oil.
The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.
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