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What to Watch for Trading Light Sweet Crude Oil

What to Watch for Trading Light Sweet Crude Oil
March 12
22:51 2012

Crude oil is one of the most popular financial instruments among speculative futures traders. It boasts high volatility in the price movement and soaring levels of volume. To successfully trade this instrument it requires traders to have an understanding of the market conditions and expectations that influence the price of oil. If a trader desires to focus on trading crude oil, there are a few news items and indicators worth following.

Before we delve into the details, here is some background. There are two important aspects that are critical in determining the price of any financial instrument, supply and demand. Changes in either area will impact the price; this is particularly true in commodities such as crude oil. Supply primarily includes the exploration and production of oil. Most of the major oil reserves and basins have already been discovered; therefore there is a very limited potential for new exploration. Oil production on the other hand has steadily risen over the years and is a large sector of the oil industry. Demand includes the refining and marketing of oil products. Refineries are used to make the products that are derived from crude oil such as heating oil, lubricating oil, gasoline, diesel etc. Marketing activities usually include servicing truck and automobile gas stations.

The supply and demand for oil is impacted by a number of things, all of which are areas worth watching for in the news:

Improvements in technology – When there are new advancements in the technology used in oil production, this is important to watch as this can expand what is feasible in production output.

Availability of equipment and qualified professionals – Oil production requires the use of drilling rigs, seismic trucks, and skilled professionals to operate this machinery. Most oil companies do not build their own equipment and rely on engineering and industrial firms, to create and operate these specialized technologies, these companies are commonly known as oilfield services. When the price of oilfield services change this impacts the entire oil production chain including exploration, extraction and transportation.

Weather – Natural disasters such as hurricanes, earthquakes and tsunamis can cause drilling platforms and refineries to shut down. Severe weather conditions in the Gulf coast region of the United States or in the North Sea region can temporarily slow or halt production.

Geopolitical conditions – The most powerful organization in oil production is the Organization of the Petroleum Exporting Countries (OPEC). OPEC is a collective of 12 countries and represents nearly 80% of the world’s oil reserves. The top five oil producing countries, Russia, Saudi Arabia, United States, Iran, and China, do not match the production capacity of OPEC. When tensions, unrest or economic turmoil occurs in oil producing countries, this can cause volatility in the price of oil.

Output and Inventory – The U.S. Energy Information Administration (EIA) produces a weekly report on key fundamental indicators for crude oil futures including changes in inventory held by commercial firms. OPEC also manages outputs and will typically announce target production levels. Both of these items add another layer of volatility to the price of oil.

Other areas to watch for crude oil include the price of the U.S. dollar, since crude oil is denominated in USD; the price of related products such as Brent crude oil and natural gas; and fluctuations in global growth as reflected by rates of change in gross domestic product (GDP) calculations.

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