How to Trade Energies

Although I know many of you understand the benefits of trading Forex, there is a world of opportunities out there just waiting for you in other markets. One of the most interesting markets is the energy market, which includes the petroleum markets, natural gas, and even some more exotic ones such as heating oil.

First things first

The first thing you need to know before trading energies is that your broker needs to offer CFD (contracts for difference) access to these markets. If it doesn’t, you’ll need to find a futures broker. The CFD markets tend to move lockstep with the futures markets, but there can be a slight difference. Over the years, I have found that the difference is negligible, and should not affect your trading results. The biggest question to ask yourself is which broker can you afford?

The reason I say this is that futures contracts are much more expensive and are thought of as a “one-size-fits-all” situation. If you decided you wanted to trade crude oil futures in the United States, each contract will require margin of over $5000. However, if you have access to a CFD broker, you can trade much smaller amounts than the standardized futures contract, giving you a smaller tick value, and of course a smaller margin requirement.

Energies have fundamentals as well

While you are probably used to looking at currencies as a reflection of economies, you should also look at energies in the same sense. For example, as we approached cold temperatures in the northeastern part of the United States late in the year, this can quite often drive up the value of natural gas. This is because the United States uses a significant amount of natural gas, and the market tends to focus on short-term gains and losses with inventory.

Another example might be crude oil markets. They may rally because of tensions in the Middle East. If there is some type of conflict or threat of a supply disruption, that will drive up the value of oil. Of course, the exact opposite is true. In the middle of 2018, Libyan supply had been disrupted, driving prices higher. However, when the ports opened up again, prices dropped.

The US dollar is crucial

While not as apparent in the natural gas markets, crude oil markets are extraordinarily sensitive to the value of the US dollar. This makes sense, because crude oil, like many other commodities, is priced in US dollars. For example, if a barrel of oil costs $75, but then the value of the US dollar rises, it makes sense that that barrel of oil will then cost less in US dollars. In some sense, you can think of crude oil as a bit of a potential “anti-dollar” play. Obviously, it’s much more complicated than that, but suffice to say the US dollar certainly has a significant amount of influence on where crude oil goes.

Economic numbers are crucial

You should never forget that energy is highly sensitive to the global economic picture. For example, if global growth is very strong, that’s typically good for energy markets. It’s because it takes energy to power manufacturing and transportation. This has a knock-on effect on both crude oil and natural gas, as both are used to power large facilities and shipping, among other things. If there is a lot of commerce going on, there is a lot of energy consumption, and demand will be higher.

Sometimes, it can be used as an indicator

A peculiar part of energy trading is that some people will use electricity, natural gas, and crude oil consumption in places like China as an early indicator of global economic strength. As China is considered the world’s factory, it stands to reason that they will be using a significant amount of energy to produce those goods being shipped around the world. Beyond that, they then will have to put energy into the boats and trucks they use for trade.

Employment in the United States, and seasonality

Employment figures in the United States, known as the Nonfarm Payroll (NFP) announcement, can often have a significant effect on energy markets as well. This is because the more people working, the more energy will be needed for manufacturing and transportation. Beyond that, there is a seasonality to the crude oil markets especially, as there is what is known as the “summer driving season” in the United States. It’s quite common for families to get in their car and drive several states away, boosting consumption of gasoline, which of course is a byproduct of crude oil.

Not all energy markets are equal

As a general rule, you should stay with the largest energy markets. West Texas Intermediate Crude, Brent, Light Sweet Crude, and Natural Gas are by far the most liquid markets. While you can trade things such as Heating Oil, those markets aren’t nearly as liquid as the larger energy markets and can be quite erratic to say the least. You will spend more time trying to research demand for those energies than the other larger markets. Beyond that, the margin is quite awful for some of these contracts. Most of the time, these energy markets are used by hedgers and not speculators. Stay where the liquidity is, and trade more fluid markets to diversify your holdings.

Currencies as a proxy

If you don’t wish to be bothered with energies in general, you can use certain currencies as a bit of a proxy. However, you should realize that there are other noisy factors involved in some of these currencies such as inflation. That being said, there are many currency traders out there that will buy and sell the Canadian dollar, Norwegian krone, Mexican peso, and a few others to mimic demand and price for crude oil, as they are all significant oil-producing states, and to some extent, the relative values of their respective currencies tends to mirror the value of crude oil.