Commodity Trading - A Beginner's Guide

Nov 20 08:53 2008 Paddy Power Print This Article

FT from the Paddy Power trader blog goes through the basics of commodities trading for newbies.

Fed up with the weekly rise in petrol prices? Hey,Guest Posting if you can’t beat ‘em, why not join ‘em. Instead of moaning about the Arabs, Chelsea tractors and Jeremy Clarkson why not thank them and learn how to make money out of the oil price?In this ‘Dummies guide to trading oil’ I’ll be having a look at the major ‘need to knows’ of the oil market, the mechanics of commodities trading and what you need to watch out for. This Price Is On ViagraOn July 11th Crude Oil hit a new record high of just over $147 a barrel - an awe-inspiring rise of 110% from last July. Over the same period the Dow fell by around 22%. This Tuesday (15th July) witnessed the biggest 1-day fall in oil for 18 years. Folks, this is a great traders’ market. How To Trade Oil Without Getting DirtyThere are two contracts available, Brent Crude and West Texas Intermediate:Brent Crude is the UK contract on oil sourced from the North Sea. And, hey! The UK might be crap at rugby, football, and cricket, but two thirds of the world’s internationally traded oil, from Europe, Africa and the Middle East, is priced relative to UK Brent Crude. In the big boys market Brent Crude is traded in London as something called Futures contracts, which are priced in US Dollars. West Texas Intermediate is the US equivalent to Brent Crude. Also known as US Light Sweet Crude (or any derivation of these words), this one is again traded as a Futures contract but in New York this time.Now, all you traders with enough balls and attention span to run your positions over a period of days and weeks, pay attention here. Oil spread bets are monthly contracts. This means that:a) You don’t pay any rollover charges; the bet will run until the contract ends.b) You do need to put a note on your Kylie Minogue calendar that the spread bet runs out (expires) on a definite date.c) Now, get this. The spread bet runs out (contract expires) in the middle of the month before the month it says on the tin. So, for example, the Brent Crude October contract on paddypowertrader runs out (expires) on 13th September and the November contract finishes on the 12th October. How dumb is that? It smacks of interference from a country that already writes the date back to front.What To Watch When Trading OilGood news if you have the attention span of a goldfish; trading oil means watching lots of telly. Wu hoo! However you won’t get rich watching the Playboy channel, while repeats of Dallas on UK Gold might be good for motivation but not much else. Trading oil is very news-orientated so keep CNBC on 24/7.The most specific economic data to focus on are the US weekly oil and gas inventory figures, issued by the Energy Information Administration and released every week on Wednesday afternoons. If you trade oil you can’t afford to miss these.Being aware of the US Driving Season (apparently the land of the gas-guzzler has a particular season for driving, starting on Memorial Day at the end of May and finishing on Labour Day at the start of September) will definitely work in your favour, and also pay attention to cold winters when we all turn the heating up.Something that’s more important again is the US Hurricane Season, which officially runs from 1st June to 30th November, but don’t expect the forces of nature to pay too much attention to the dates. An average season has 11 named storms with six growing into hurricanes, but only two reach major hurricane status. So don’t go buying oil every time your weathercock spins round. So why is the hurricane season so significant to the oil market in particular? Hurricanes tend to hit the Gulf of Mexico, which is filled to the rafters with oilrigs (over 20 rigs went missing due to Hurricane Katrina in 2005).Next take a look at the world’s big oil producers. You won’t find oil gushing out of countries like Belgium, Holland or Sweden, where even mentioning their name is soporific. No, putting aside the comparatively stable USA and Saudi Arabia, God blessed the world’s more excitable countries with the power and wealth of massive oil supplies. A short roll call includes Iraq, Iran, Libya, Nigeria, Venezuela and Russia, where a few well-chosen words from a president can send you sprinting to the ‘trade’ button. So What’s Driving The Oil Price?Ask any politician and he’ll spit out the word, “Speculators”. Out in the real world there are a number of factors, though most hone in on the common perception that demand is greater than supply. This list is far from exhaustive, but will give you a feel for what matters:• The easy-to-get oil has already been drilled. The next easiest to get oil is the wrong type; it’s ‘sour’ (rather than ‘sweet’) and more expensive to refine. There may be vast oil reserves in places like Canada’s tar sands, but these will be hugely expensive to get at.• Geo-political tensions in oil-producing countries. One day it’s militants in Nigeria, another day its Israel and Iran at each other’s throats. Tomorrow it’ll be someone else. These tensions are hugely significant because whenever someone throws their toys out the pram it threatens to disrupt the supply of oil.• The Dollar. Oil is priced in Dollars, so if the Dollar falls the oil price rises to maintain a constant value in other currencies. This move has been compounded by investors piling money into oil as a hedge against the weaker Dollar.• Inventories. The oil price is massively sensitive to the build up, or run down, of oil supplies. The most keenly watched figures are the stats from the US Energy Information Administration, released each Wednesday.How To Trade OilYou can either trade oil through the equity market or through the oil spread bet. Let’s have a look at equities first.Now here’s something to make you choke on your sandwich; the oil majors are having a really crap time! But why? Well, it may not seem like it to you and me, but part of the problem is that petrol prices haven’t kept up with the rise in crude prices; the jargon is that the refining margins have fallen, and that’s quite a significant chunk of their business. The other problem is that these guys spend a lot of time sticking rods in the ground to see if anything spurts up and that costs a lot of money.There are exceptions; smaller companies like Tullow Oil and Dana Petroleum have had a cracking time. Each new discovery has notched up a couple of quid on the share price. And they’ve got the added attraction that one of the majors might decide it’s cheaper to bid for them than to look for new reserves itself.Until recently few people outside of Ireland had heard of Tullow. Nowadays, after several successful oil discoveries, it’s a FTSE 100 company.There are alternative ways of playing the oil price. The rise and fall of shares in airline companies has been related to the oil price. However, there are other factors too (BA suffered the Terminal 5 debacle) so it’s not a perfect strategy.The purest solution, if you want to follow the rise and fall of oil, is to trade the commodity itself. And spread betting is arguably the most convenient way of doing that.ConclusionSo now you should be armed with the ideas on how to trade oil, who and what are important and a rough idea of the sort of things that drive the oil price.Just a word of warning for newbies to spread betting. Hidden inside this mountainous price rise are some nasty crevices. The volatility that makes this market so great can still eat you up and spit out the bony bits. Do your trading capital a big, big favour and use a demo account for a while whilst you learn the tricks of the market. Then edge in gently with small bet sizes. There’s no rush, there’ll always be a market to trade in when you’re ready.

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About Article Author

Paddy Power
Paddy Power

Mr FT is a self-employed spread better. After 18 years in fund management he was given the choice of moving to London or .. not. ‘Not’ won out.

FT has been trading full time from home for two years, with nothing but four kids and a beach to distract him .

He fills his spare time with weight training and rugby, though more coaching than playing these days.

FT mostly trades the forex markets and although he plays FTSE on occasions his bread and butter market is £$.

Read more from FT on commodities trading and spread betting on the Paddy Power blog at

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