Volatility, that derided word that investors don’t want to hear. Who would want to watch their investment tossed around like a canoe in a hurricane?
However, for traders, volatility need not be a curse word. An asset that fluctuates frequently offers numerous opportunities to profit from both its upward and downward movements.
This is especially true for crude oil traders. Instead of deriding the volatility of this commodity, smart investors will embrace the right crude oil trading strategies that will help them profit from its fluctuations.
In what follows, we consider six tips that can help crude oil traders prosper even in volatile markets.
Brent and WTI crude oil often trade at different prices. Efficient traders can explore the arbitrage opportunities that this diversion creates.
Interestingly, when volatility increases, the spread between the two benchmarks can widen (as it happened during the COVID-19 pandemic). This can especially happen when the causes of the increasing volatility are specific to only one of the benchmarks.
Arbitrage opportunities can also open up when crude oil’s implied volatility diverges from its realized volatility due to geopolitical shocks. Efficient traders can exploit mispriced option premiums in such markets.
Finally, rising volatility can cause crude oil futures to move between contango and backwardation. Traders can buy and sell futures contracts to take advantage of the mispricing.
In a volatile market, crude oil is either in an upward or downward trend. That is, it does not consolidate within a range.
A trend following strategy becomes appropriate in such conditions. Efficient traders will go long in an uptrend and go short in a downtrend.
In other words, when the market is volatile, counter-trend trades become riskier (since pullbacks are often short-lived) while trend-following strategies prove more appropriate.
Most of the factors that drive crude oil prices’ volatility are related to broader economic and political news events – Middle East tensions, economic sanctions, currency fluctuations, OPEC supply decisions, changes in energy policies, among others.
When you pay attention to the news, you can anticipate the potential effect of developing news events and trade in that direction. This allows you to capture large price movements compared to those who wait for the news to unfold.
You can also consider trading the mean reversion between crude oil and other related assets – natural gas and renewable energy.
When the crude oil-natural gas ratio diverges from its historical average, then you know that there has been heightened volatility. You can long the undervalued asset and short the overvalued one in expectation of a reversion to the historical average.
You can do the same for renewable energy (through a renewable energy ETF or index fund). By tracking the ratio of the prices of crude oil and a renewable energy index, you can identify when they become overvalued/undervalued. This allows you to execute a mean reversion strategy in anticipation of a correction.
The perfect trader who gets it right every time has not yet been born. This is why risk management will always be essential, irrespective of how much fundamental and technical analysis you know.
In this regard, ensure that crude oil is not the only asset you trade. You can reduce your overall risk by diversifying your exposure. For example, you can learn how to invest in gold in the UAE.
More importantly, when going long or short, remember to set a stop loss order. When markets are very volatile, you can quickly lose a huge chunk of your capital in a few minutes or hours.
Instead of allowing the market to decide how much you lose, set up your trade to cap your losses at an amount you are comfortable with.
The fear-and-greed cycle is not only a stock market phenomenon. It is human psychology, so it applies to all financial markets.
When volatility is high, fear and greed can easily set in. It is in those exact moments that you need to stick to your strategy.
Trading should not be like throwing spaghetti at the wall to see what sticks. Rather, it should be based on a strategy that you have proven to succeed more than it fails and makes more money when it works than it loses when it doesn’t.
Such a strategy-based approach is the ultimate remedy for panic-based trading.
If you are in the UAE, you can trade crude oil CFDs with Daman Markets. They provide you with all the information you need for sound fundamental and technical analysis as well as personalized support that will make your experience seamless.
The high liquidity they provide also helps to minimize bid-ask spreads and ensure fast trade execution. This makes it easy for you to execute arbitrage strategies.
If you are interested in profiting from crude oil price fluctuations, Daman Markets is one brokerage company to explore.
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