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The traditional way to trade the crude oil market involved actually buying oil. If you had enough money, you could buy your own oil well. Alternatively you could buy and sell shares in oil companies.
Today, there are other ways of making profits / losses in the oil market; trading futures is one example. A futures contract for, let us say, 1,000 barrels of oil is an option that gives you the right to buy that quantity at a certain price at a specific time, for example 90 days from now. If prices rise, in the meantime, your option will increase in value and you will be able to sell it at a profit on or before the settlement date, unless you wish take physical delivery of the oil.
Another popular option is spread betting. Both this and futures are known as 'derivatives,' which means prices are derived from the value of the underlying asset, in this case oil. With financial spread betting, you can put down a smaller deposit than with futures. A spread betting contract with a ratio of 100:1 means you only have to put down a deposit equal to 1% of the actual value of the oil you are betting on.
With both futures and spread betting you can make or lose money whether the price goes up or down. However, as enticing as this may sound, spread betting is a leveraged product; it involves a high level of risk to your capital and you must still correctly predict the direction of the movement or you could lose more than your initial deposit.
Please ensure that spread betting fits your trading objectives as it may not be suitable for all types of investor. Ensure that you only speculate with funds that you can afford to lose. Before trading, please ensure that you are fully aware of all the risks involved and where you feel it is necessary seek independent advice.
Take, as an example, spread betting on the prices of a barrel of oil. If, after studying the fundamental and/or technical indicators, you believe that the price will either go up or down, you can enter into a long or short contract respectively. A long contract simply means you expect the price to increase, while a short contract means you expect the price to fall.
There is no direct commission involved, instead it is the difference between the offer and bid prices. This is called the spread and usually represents only a small percentage of the total contract value.
Let us assume you expect the price of oil to rise and so you buy the crude oil spread betting market at the current offer price. You will be required to make a deposit; with oil it is often in the region of 1% of the value of the oil you are betting on.
Should the price increase by, let us say, half a percent during the next few days, you could terminate the contract and take your profit. A 0.5% price increase will give you a 50% profit on your initial deposit; similarly, a 0.5% price fall will mean you lose 50% of your deposit.
Should the price of oil suddenly drop by 1%, you would lose your entire deposit. Fortunately, you can limit the amount of loss you expose yourself to by setting up a guaranteed stop loss order at a predetermined level.
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