Crude Oil Trading Strategy — What Is It? (Backtest) – Quantified Strategies For Traders And Investors

Last Updated on March 3, 2023

Crude oil is one of the different assets you can dabble into as a trader, but the market is quite difficult to master because of the many factors that affect it. If you must trade it, you will need to have a backtested crude oil trading strategy.

The crude oil trading strategy is the buying and selling of different types of crude oil contracts with the aim of making a profit from the fluctuation of oil prices.

Crude oil is a naturally occurring, unrefined liquid petroleum that is extracted from the ground and can be refined into various products like gasoline (petrol), kerosene, diesel, lubricants, wax, and other petrochemicals. It is the world economy’s primary energy source, which makes it a very popular commodity to trade.

In this post, we take a look at crude oil and how to trade it. We provide a FAQ about crude oil trading, and at the end, we have a backtest of several crude oil trading strategies.

What is crude oil?

Crude oil is a naturally occurring, unrefined liquid petroleum that is extracted from the ground. It was first discovered and developed during the Industrial Revolution, and it is still powering the world’s economy today. Present underneath the earth’s crust, it is typically obtained through drilling, alongside other resources, such as natural gas.

Crude oil has a range of viscosity and can vary in color from black to yellow depending on its hydrocarbon composition. It can be refined into various products like gasoline (petrol), diesel, kerosene, asphalt, lubricants, wax, and other petrochemicals. These products are used to fuel our automobiles, aircraft, and various industries, including cosmetics, fabrics, and pharmaceuticals.

As the world economy’s primary energy source, crude oil is one of the most actively traded commodities in the world. Crude oil is a nonrenewable resource; it can’t be replaced naturally at the rate we consume it. So, it is available in a limited supply, which is why the demand is high, creating massive price fluctuations that traders try to profit from.

Dubbed the “black gold”, crude oil is a popular commodity, and its demand often sparks political unrest because a small number of countries, especially in the Middle East, control the largest reservoirs. Saudi Arabia, Russia, and the US are the leading producers of oil in the world. The supply/demand dynamics and the resultant massive price fluctuations make crude oil trading popular among commodity traders.

There are many different types of crude oil traded on the global market, but only two primary types serve as global benchmarks for crude oil prices. They are:

1. Brent Crude Oil: This is obtained from oil fields in the North Sea. It is characterized as a “light and sweet” oil, although it is not as “sweet” or “light” as WTI. Brent Crude Oil constitutes about two-thirds of global crude oil contract trades.
2. WTI Crude Oil: West Texas Intermediate (WTI), as the name suggests, is gotten from US oil fields primarily in Texas, Louisiana, and North Dakota. It is referred to as ‘light sweet crude oil’ due to its low density and low sulfur content, which make it less expensive to produce and easier to refine than ‘heavy’ or ‘sour’ oils. It is the main benchmark for oil consumed in the US.

Is crude oil good for trading?

As with other commodities, crude oil contracts are traded for speculative or hedging purposes — to profit from the fluctuation in oil prices.

But for a retail trader with limited analysis capabilities, is crude oil good for trading?

Well, we don’t think so. We believe crude oil is difficult to trade because it’s influenced by a lot of macro news that is nearly impossible to track or forecast.

Besides, there is no tailwind like in stocks, which can go up in the long run (please read night trading stocks to understand why). Crude oil prices have no general direction. It’s at the mercy of geopolitical risk (more or less all the time). It’s a strategic “weapon” that is used to gain geopolitical leverage.

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In fact, price changes are often associated with world politics. A cough by the Saudi Arabian crowned prince could send crude prices soaring or plummeting, let alone a phone call between Saudi and Russia. The same can be said of OPEC meetings, US sanctions on some countries like Iran and Venezuela, trade wars, and Middle Eastern geopolitical crises.

There are just too many variables at play that can move the prices of crude oil, which you may not be able to track as an individual trader. The demand and supply dynamics are too politically motivated to be predictable. So, given the unpredictable volatility and factors affecting the market, crude oil trading can be very risky for a retail trader with limited resources.

However, for diversification purposes, any crude oil trading strategy is very valuable – if you find something that is consistent. But compared to stocks, we rarely find something that lasts over many years.

Where can you trade crude oil?

You can gain exposure to the crude oil market in different ways, including futures, options, stocks, ETFs, and CFDs.

• Futures: Crude oil futures are contracts to exchange an amount of oil at a set price on a set date. Oil futures are a common method of buying and selling oil, and they enable you to trade rising and falling prices. You can trade futures contracts of any of the two types of crude oil (Brent or WTI) on a commodity futures exchange, such as the Intercontinental Exchange (ICE), New York Mercantile Exchange (NYMEX), and the CME Group’s Globex platform. You can access the exchange by opening an account via a futures broker.
• Options: Crude oil options contracts give you the right to buy or sell an amount of oil at a set price (strike price) on or before a specified expiry date (expiry trading), but you wouldn’t be obliged to exercise your option. Options contracts are also traded on futures exchanges, and you would need to open an account with a broker to have access to the market. There are two types of options contracts: call options and put options. You buy a call if you think the prices would rise and buy put if you think prices would fall. (Please read our take on SPY covered call and trading spy options.)
• Stocks: You can gain exposure to the crude oil market by trading stocks of companies that are involved in crude oil exploration, refining, and marketing. Stocks are traded on stock exchanges; to trade them, you have to open an account with a stockbroker, for example, Interactive Brokers.
• ETFs: Another way to gain exposure to the crude oil market is to trade ETFs, which are a collection of crude oil stocks. Some crude oil ETFs invest in crude oil futures or track the futures prices. You can buy and sell crude oil ETFs in the same way you do stocks in the stock market. When the price of oil fluctuates, it affects the share prices of crude oil stocks and, subsequently, the value of the ETF.
• CFDs: Crude oil CFDs (contracts for difference) are contracts with an online broker to exchange the difference in the price of crude oil contracts between the time you open a trade and the time you close it. To trade crude oil CFDs, you have to open an account with a CFD broker. This is the easiest way to trade crude oil, as you do not have to worry about asset delivery associated with futures trading.

What is the best strategy for trading crude oil?

There is no best strategy for trading crude oil, but we believe that trading based on seasonality is the best approach. Seasonality refers to significant patterns in the price movement of an asset during certain times of the season. Since crude oil is refined into gasoline and distillate, the seasonal trends in crude inventories are in line with the demand for gas and distillate. Seasonal peaks usually appear in April, May, and November, while troughs appear in January and September.

(As a matter of fact, most of the gains have come from the end of November to the end of April – please read our seasonal trading strategy in crude oil.)

In addition, analyzing macroeconomic events that happen around the world and how they might affect the crude oil market is the only way to stand a chance of making profits from crude oil trading.

FAQ crude oil trading strategy

Based on the number of e-mails we get, we decided to make a FAQ to better address any issues about the crude oil trading strategy:

What is the best strategy for crude oil trading?

In trading, there is no “best strategy”. If it works, it works. The only holy grail trading strategy is that you must have many trading strategies spread over as many asset classes as you find profitable.

Which trading indicator is best for crude oil trading?

Traditional oscillating or mean reversion indicators don’t work well in the crude oil market. As a matter of fact, in the few crude oil trading strategies we trade ourselves, we don’t use any indicator at all. Instead, we rely on the time of the day and the time of the week (plus one or two other parameters).

Is crude oil good for trading?

Our experience indicates crude oil is very tough to trade. It’s hard to find any profitable strategies, and those which pass our incubation period are much less likely to last for a long time, unlike stock trading strategies, for example.

What is the best time to trade crude oil?

The best time to trade crude oil is late in the week. Apart from that, there are some seasonal trading edges that have been reasonably consistent for a number of years.

Can you scalp crude oil?

Of course, you can, but you are most likely ending up penniless. You can read here why scalping is not profitable.

How much do crude oil traders make?

The majority probably loses money. The futures market is a zero-sum game – and so is the crude oil market. How many traders fail? A fair estimate is around 90%.

You must also keep in mind that the futures market is often used for hedging, not for speculation.

Crude oil trading strategy video

The backtest below is described in our crude oil video:

Crude oil trading strategy (backtest and example)

Let’s backtest a crude oil trading strategy with trading rules and settings (WTI). We’ll start with one strategy we published as far back as 2013, called Friday seasonality in USO (oil).

The trading rules are these:

• Calculate the 25-day average of the daily High minus the Low (daily prices).
• Today is Tuesday or Thursday.
• The close today must be lower than yesterday’s close minus the range in number one.
• We sell at the close of the next trading day.

This time we don’t backtest USO (an ETF that tracks crude oil) but rather the futures contract (@CL).

The historical performance has been decent and the trading performance metrics are good:

Crude oil trading strategy backtest (long)

(The backtest is not a futures backtest with margin and points. Instead, we used an “equity backtest” with no leverage, although the @CL contract is used.)

There are 341 trades with an average gain per trade of 0.25%, more than enough to make a decent profit. The win rate is 58% and the average winner is bigger than the average loser. Max drawdown might be a problem, though. Profit factor is a bit low at 1.65.

Crude oil trading day trading strategy

We have one day trading crude oil strategy, but that one we prefer to keep ourselves. It’s one of the few day trading strategies for crude oil that has held up well for many years.

Below are a couple of equity curves of strategies that we found a couple of years back when we researched the article called which day of the week is stocks most volatile.

We have the two strategies in incubation (or under surveillance, so to speak). The first strategy buys in the morning and closes the position in the evening depending on one single variable:

Crude oil day trading strategy (long)

It trades very frequently: 411 trades, the average gain is 0.19%, and the probability of having a winner is 60%. But it has suffered from long periods of drawdowns or flat performance. It’s a long strategy.

The other is a short strategy, and as expected for a short strategy, it’s pretty inconsistent and probably not tradable:

Crude oil day trading strategy (short)

Crude oil strategy video

We have made a video of a crude oil strategy:

List of trading strategies

Since we started this blog in 2012, we have written many trading strategies that you can read for free, please see our complete list of trading systems. We have compiled the Amibroker code and logic in plain English for all these strategies (plain English is for backtesting in Python) in addition to the crude oil strategy we backested in this article by using daily bars (EOD strategy). If you subscribe, you’ll get the code for the latter strategy (plus over 150 other ideas).

For a list of the strategies we have made please click on the green banner:

These strategies must not be misunderstood for the premium strategies that we charge a fee for:

Crude oil trading strategy video

We made a short video of the crude oil trading strategy video.

Crude oil futures

Crude oil futures are one of the world’s most actively traded commodity futures. Crude oil futures refer to a financial derivative product that represents a contract to buy or sell a specified quantity of crude oil on a future date, at a pre-agreed price. The contract trades on ICE Futures Europe and CME.

What are Crude Oil futures?

Crude oil futures are futures contracts with crude oil as the underlying asset. Such contracts represent a legally binding agreement to receive or deliver the specified quantity of crude oil on a future date, at a pre-agreed price. The contract trades on the CME Group (NYMEX) and ICE, and it is settled by the physical delivery of the specified quantity and quality of crude oil at the expiration of the contract — the seller of the crude oil futures contract delivers the specified quantity and grade of crude oil to the buyer through the exchange.

Traders who just want to speculate on the crude oil price without getting involved in the delivery can close out their trades before expiry or roll over their contracts. Commodity speculators love to trade crude oil because of its liquidity and the opportunities to take advantage of price fluctuations.

There are two major types of crude oil futures: Brent crude and West Texas Intermediate (WTI). The WTI crude, also known as light crude oil, is used as a benchmark in oil pricing and is most cited in oil prices. Brent crude, on the other hand, comes from the North Sea and is not light like WTI crude. WTI Crude Oil futures, the world’s most liquid oil contract and has been trading on the NYMEX since 1983.

What is the seasonality of Crude Oil futures?

When it comes to financial trading, seasonality refers to the tendency of an asset’s price to move in a fairly predictable way during certain periods of the year. The periods here may refer to the months of the year or the four seasons (winter, spring, summer, and fall) of the year.

Crude oil futures have been noted to perform better during the spring and summer months than during the fall and winter. See the chart below:

Source: Equity Clock

How are Crude Oil futures traded?

Crude oil futures contracts are traded on ICE Futures Europe and CME Group’s Globex platform. On the ICE futures exchange, Brent crude oil futures (with the trading symbol, BRN) trades from 1:00 AM – 11:00 PM London Time every trading day, from Sunday (11: 00 PM) to Friday. There is a pre-Open market from 12:45 AM. The contract size is 1,000 barrels, and the price quotation is in US dollars and cents per barrel. The contract is deliverable.

On the CME Globex platform, the WTI Crude Oil futures contract (CL) trades Sunday-Friday, from 5 p.m. to 4 p.m. Central Time (CT), with a daily 60-minute break at 4 p.m. CT. As with ICE, a contract unit is 1,000 barrels of crude oil, and prices are quoted in USD and cents per barrel. Settlement is by physical delivery, and trading terminates on the last business day of the month prior to the contract month.

The contract trades on margin, so only a fraction of the total worth is required to trade it. Throughout the life of the contract, the clearinghouse marks the contract to market, so the daily differences in price are settled at the end of each trading day — traders in winning positions have their profits added to their accounts while those in losing positions have their accounts debited.

How do you start trading Crude Oil futures?

To trade the contract, you need a futures broker that will grant you access to the exchanges where coffee futures contracts are traded. The first step is to register with a futures broker, such as TradeStation, and fund your account.

However, if you just want to speculate on price movements, you may trade the CFD of crude oil futures contracts via an online CFD broker, such as IG. With CFD, you can speculate on price fluctuations without having to worry about the rigors of asset delivery or contract expiry.

What’s Crude Oil futures hour?

On the ICE futures exchange, crude oil contracts trade from 1:00 AM – 11:00 PM London Time every trading day, from Sunday (11: 00 PM) to Friday. There is a pre-Open market from 12:45 AM.

On the CME Globex electronic platform, crude oil futures trade Sundays to Fridays, from 5:00 p.m. to 4:00 p.m. CT the next day. There is a 60-minute break before the start of the next trading day (4:00 p.m. – 5:00 p.m. CT) from Monday to Thursday.

What are the trading symbols for Crude Oil futures?

The trading symbol of Brent crude oil futures on ICE Futures Europe is BRN, while the trading symbol for the WTI crude oil futures on the CME Globex platform is CL.

What is the specification for the Crude Oil futures contract?

On both ICE and CME, one contract of crude oil futures is equivalent to 1,000 barrels. The price quotation is in US dollars and cents per barrel. The minimum fluctuation is one cent ($0.01) per barrel, which is equivalent to a tick size of $10 per contract.

Monthly contracts are listed for the current year and the next 10 calendar years, plus 2 additional contract months. Monthly contracts for a new calendar year and 2 additional contract months are listed following the termination of trading in the December contract of the current year. The contract is settled by physical delivery on both exchanges.

On ICE, trading terminates at the end of the designated settlement period on the last Business Day of the second month preceding the relevant contract month — for example, the March contract month will expire on the last Business Day of January. For CME, Trading terminates 3 business days before the 25th calendar day of the month prior to the contract month, and if that day is not a business day, trading terminates 4 business days before the 25th calendar day of the month prior to the contract month.

What is the contract size?

One contract of crude oil futures is equivalent to 1,000 barrels of crude oil on both CME and ICE exchanges. With the price of a barrel of WTI crude oil on CME, as of writing, at $71.44, the USD worth of a full contract of WTI crude oil futures (CL) is 1,000 x $71.44 = $71, 440.

What is the tick size?

The tick size is $10.00 per contract.

What is the minimum price fluctuation for Crude Oil futures?

The minimum price fluctuation is one U.S. cent ($0.01) per barrel.

What is the settlement method?

Deliverable

What is the settlement procedure?

On expiry, the seller delivers the specified quantity and grade of crude oil to the buyer, under the supervision of the exchange. Meanwhile, daily settlement applies until contract expiry.

What is the block minimum for Crude Oil futures?

The block minimum for WTI crude oil futures (CL) on NYMEX (CME Group) is 50 contracts.

What is the difference between Crude Oil futures and the CFD for Crude Oil?

Crude oil futures have expiry dates and may involve the delivery of the asset, while crude oil CFDs can be traded without such worries.

Are there any oil price ETFs?

Yes, there are many. These are a few of them:

• iPath Pure Beta Crude Oil ETN (OIL)
• ProShares UltraShort Bloomberg Crude Oil (SCO)
• ProShares K-1 Free Crude Oil Strategy ETF (OILK)
• United States 12 Month Oil Fund LP (USL)

Crude oil trading strategy – conclusion

As we have mentioned in the article, crude oil is a pretty difficult asset to trade (compared to stocks – our favorite asset). If you are not successful at trading stocks, we believe it’s even more unlikely you’ll succeed with any crude oil trading strategy.

But any crude oil strategy is likely a great addition to a portfolio of trading strategies (because it’s likely slightly uncorrelated to the performance of the stock market).

To sum up, any crude oil trading strategy is likely to be both less robust than any stock/equity strategy and less likely to pass the incubation period (what is out of sample backtesting).