Trading oil may seem exciting and where it’s at because the oil market is mentioned in the news every day. Trading it may make you feel like you’ve elevated your status as a trader. Like many commodity futures contracts, the black gold can be volatile. And while you may find that exciting, be sure your account — and your nerves — can handle the volatility.
A good litmus test is to look at the 20-day Average True Range, or ATR. The ATR does what it says on the tin: it gives you an idea of the average range the price can move on any given day based on an average of the last X days (in this case 20). I like to think it gives me a idea of a contract’s personality.
Looking at Crude Oil: Light Sweet Crude Oil (West Texas Intermediate) The ATR is currently $2.14.
Now given that the standardized contract size is 1,000 barrels, you can expect the average daily non-directional movement to be $2,140 – a potentially large swing in your equity.
Is your account big enough to trade the contract? Consider what I mentioned in an earlier post entitled Meaningful Risk?.
Risking 1% of your account equity, position sizing accordingly would suggest that in order to trade this contract, you’d need capital in the region of $214,000 if you were to place your protective stop 1 ATR away from your entry price.
If you aren’t sufficiently capitalized and you emotionally must trade oil, then you might consider looking at the options offered by ETF’s (Exchange Traded Funds) in the US or in Europe / Australia consider CFD’s (Contracts For Difference). You can also consider trading the mini contracts if your style is suited for commodity futures.
Then there is the question of the thickness of your stomach wall you have for this market. A brief snapshot of the fundamentals surrounding this market at the moment suggest you’ll need a thick one:
* Slowing of World economy: China slow down, European mess
* An understanding of how OPEC works
* The Middle East and the escalating tensions with Syria
* Israel / Palestine bombing in Gaza
* Upcoming Israeli elections and the ongoing problems with Iran
* Iran and its ongoing problems with it seems just about everyone else
* Iraq’s production
If you take all of this into perspective, you may see that by trying to up your status, you concurrently up the probability of taking a destabilizing financial loss. Know yourself.