6 Ways to Trade Crude Oil

09/17/2013 7:00 am EST

Focus: ETFs

Oil has been hot and volatile and could stay that way with the Fed taper on tap, writes the staff of Wall Street Sector Selector.

When the Bureau of Labor Statistics calculates the “core” Consumer Price Index, food and energy expenses are excluded because those sectors are volatile, making it difficult to track the broader economic trend.

It is the volatility of oil prices, which makes this commodity so attractive to traders and investors. While there is a tremendous upside for making profits, the downside risk is also more significant than it is for other commodities such as base metals.

Using ETFs for trading oil makes it easy for the retail investor to take advantage of this market volatility, which until approximately 10 years ago, was the exclusive domain of commodities investors and traders. Because ETFs are traded in the same manner as stocks, equities investors can stick with their familiar trading platforms and sources of market data in making investment decisions.

Retail investors find that a key advantage of using ETFs for trading oil is that the process for conducting technical analysis of a particular ETF is the same process as used for making a technical analysis of a stock or an equity-based ETF. Chart-reading becomes the key for following the market and building trading strategies. The old, familiar patterns bring the same signals. If the relative strength index is over 70, that oil ETF is “overbought”. If the MACD has crossed below the signal line and is headed for the zero line—consider something else. If the ETF just crossed above its 50-day moving average—start thinking about how much you want to invest.

ETFs make “fundamental analysis” of the oil market unnecessary for the retail investor who simply follows the charts. Supply-and-demand considerations, political upheavals and weather problems are left to economists, commodities traders, and anyone else with such a focus.

The oil ETF universe offers opportunities for making “long” or “short” trades, by way of “long” and “inverse” ETFs. Those who want to get more “bang for the buck” can take advantage of leveraged ETFs—as well as leveraged inverse ETFs—if they are willing to assume the downside risk.

Investors seeking to profit from increasing oil prices may want to consider one or more of the following ETFs:

United States Oil (USO) – This ETF is designed to obtain investment results, which correspond to the performance of the spot price of West Texas Intermediate light, sweet crude oil. The fund will invest in futures contracts for WTI light, sweet crude oil, other types of crude oil, heating oil, gasoline, natural gas and other petroleum based-fuels that are traded on exchanges.

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United States 12-Month Oil (USL) – This ETF is designed to replicate the changes in percentage terms of the price of light, sweet crude oil delivered to Cushing, Oklahoma, as measured by the changes in the average of the prices of 12 futures contracts on crude oil traded on the NYMEX. USL will consist of the near-month contract to expire and the contracts for the following eleven months, for a total of 12 consecutive months’ contracts. When calculating the daily movement of the average price of the 12 contracts each contract month is equally weighted.

Energy Select Sector SPDR ETF (XLE) – This ETF is designed to obtain investment results, which correspond to the price and yield performance of publicly traded equity securities of companies in the Energy Select Sector Index. In seeking to track the performance of the index, the fund employs a replication strategy. It generally invests substantially all, but at least 95%, of its total assets in the securities comprising the Energy Select Sector Index. The index includes companies from the following industries: oil, gas, and consumable fuels; and energy equipment & services.

Investors seeking to profit from declining oil prices may want to consider one or more of the following ETFs:

United States Short Oil (DNO) – This ETF is designed to replicate the inverse percentage changes of the spot price of light, sweet crude oil delivered to Cushing, Oklahoma. It will be measured by the changes in the price of the futures contract on light, sweet crude oil as traded on the NYMEX that is the near month contract to expire, except when the near month contract is within two weeks of expiration, in which case the futures contract will be the next month contract to expire.

ProShares Short Oil & Gas ETF (DDG) – This ETF is designed to obtain daily investment results, which correspond to the inverse (-1x) of the daily performance of the Dow Jones US Oil & Gas Index. DDG invests in derivatives, which ProShares Advisors believes, in combination, should have similar daily return characteristics as the inverse (-1x) of the daily return of the Dow Jones US Oil & Gas Index. The index measures the performance of the oil and gas sector of the US equity market. Component companies include, among others, exploration and production, integrated oil and gas, oil equipment and services, pipelines, renewable energy equipment companies and alternative fuel producers.

ProShares UltraShort Dow Jones-UBS Crude Oil ETF (SCO) – This ETF is designed to obtain investment results, which correspond to twice (200%) the inverse of the daily performance of the Dow Jones-UBS Crude Oil Sub-Index. SCO invests in any one of or combinations of the financial instruments (swap agreements, futures contracts, forward contracts, option contracts) with respect to the applicable fund’s benchmark to the extent determined appropriate by the sponsor.

Bottom line: Oil provides ongoing opportunities for active traders, and now, through the power of ETFs, retail players can get in the game with the major hedge fund and oil speculators. But the market is volatile and not for sissies and requires a solid trading program and risk management for success.

By Staff of Wall Street Sector Selector

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