Oil. You may have heard that it’s a non-renewable resource. And you already know how much the global economy depends on it. So won’t the price of oil keep rising, you ask? In this article we’ll go over the pros and cons of buying oil futures. When you buy oil futures, you’re betting money that you know how the price of oil will change in the future. If that sounds risky, it’s because it is.
How Oil Futures Work
When you invest in oil futures, you’re not actually investing in the oil itself. This means you don’t have to store barrels of crude oil in your garage. Instead, you’re investing in a futures contract and betting on the price of oil. There are other forms of oil-related investments, like buying shares in oil companies or oil ETFs.
But let’s focus on oil futures. When you buy oil futures, you’re staking a position on the movement of oil prices. This could be a long position (you’re betting that oil prices will rise) or a short position (you’re betting that oil prices will fall).
Let’s say you decide to take a long position on oil prices. You buy a stake in an oil futures contract on the New York Mercantile Exchange (NYMEX) through a broker, paying a certain price per barrel of crude oil for 1,000 barrels. Later, you learn that the price per barrel has risen, so you decide to exit your position by selling your side of the futures contract.
You, my friend, just made a profit (once you subtract your initial investment and the fees you paid). But if oil prices had dropped, you would have lost money. It’s also possible to buy futures on margin, meaning that you only have to put up a fraction of what your stake is worth. This means you stand to make bigger gains, but it can also lead to bigger losses. It’s a good idea to approach this strategy with caution.
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How to Buy Oil Futures
It’s easy to read news about movement in oil prices. You hear on the news when prices rise and fall, but to succeed as an investor in oil prices, it’s not enough to react to that news. You have to find a way to anticipate the changes.
You may read that prices have risen and decide to take a long position, assuming that that trend will continue. But if there’s one thing to remember about investing, it’s that past performance is not a guarantee of future returns. In other words, you can’t know that oil prices will continue to rise. In fact, oil prices are quite volatile. That means you stand to lose the money you invest.
If you still want to try your hand at trading oil futures, you’ll need to go through a brokerage firm, and not all firms give the option of investing in commodity futures. When you find a brokerage firm online that lets you trade futures, it’s important to check its credentials against SEC and FINRA records. Confirm what your liability will be if you trade on margin, and start small. Oil futures are not the place to put your retirement savings or the down payment you plan to make on a home one day.
The average investor doesn’t need to dabble in oil futures – or any kind of commodity futures trading for that matter. We’re all busy with jobs, friends and hobbies. There’s no need to take time out of your packed schedule to research oil prices and try to get rich by speculating on oil futures (unless you want to and have the money to lose, of course). The average investor will likely be better off looking for less risky, low-fee investing options that you can “set and forget.”
Photo credit: © iStock/Michal Krakowiak