Learn with ETMarkets: How to trade crude oil futures using moving averages?

Crude oil, also known as black gold, is extracted and refined into various useful products such as gasoline, jet fuel, and many other petroleum products. It is a crucial raw material used in various industries, including transportation, chemicals, and manufacturing.

West Texas Intermediate (WTI) and Brent Crude are the primary types of crude oil that are traded in the international market. WTI is primarily sourced from the United States. It is lighter and sweeter crude oil, meaning it has lower density and lower sulfur content than Brent, making it easier and cheaper to refine into gasoline and other petroleum products than Brent Oil.

OPEC plus controls 40-45% of the world’s crude oil production. This group consists of 13 OPEC members and 10 other allied oil-producing nations. They can influence the oil prices and the oil market by cutting production or ramping up the supply. In India, crude oil is traded on different exchanges, but most of the volumes are traded on the Multi Commodity Exchange of India Limited (MCX).

Commodity market timing

In MCX, the market opens at 9 am and closes around 11:30–11:55 pm, considering the half-yearly day/light shift. The international market is open 24/5 with a small break.

Factors that affect crude oil prices

Several factors can drive fluctuations in crude oil prices:Supply and Demand: The prices of all the major commodities, including crude oil, are determined by their supply and demand.Crude oil inventory data: Crude oil inventory data is out every Wednesday. An oversupply can put pressure on the price, while low inventories may cause prices to spike.

Geopolitical Events: Conflicts or tensions in oil-producing regions can disrupt supply chains and can affect prices. Recently, a cold war-like situation between Iran and Israel has increased the volatility, and prices have spiked by almost ten per cent from their recent swing low.

Currency Fluctuations: Oil prices are generally quoted in US dollars. A strong dollar can make oil more expensive for countries that import it.

OPEC Decisions: As previously mentioned, OPEC significantly influences oil prices. Their decision to increase or cut production is closely tracked worldwide, which may affect Crude oil prices.

Economic Indicators: Economic data from the US, such as unemployment rates, manufacturing output, and Non-farm payroll data, can indicate the health of an economy, which in turn can affect oil consumption and prices.

Natural Disasters: Events such as hurricanes, earthquakes, and other natural disasters can disrupt oil production and supply chains, leading to fluctuations in crude oil prices.

Trading Crude oil with Moving Averages:

Given the dynamic nature of the commodities market, which operates 24/5, using technical indicators like Moving Averages (MA) can be effective for trading crude oil. There are different types of moving averages, but the following are the most commonly used:

• Simple Moving Average(SMA): This is calculated by adding the prices over a specified period and dividing the total by the period. For example, a 20-day SMA is the average of the closing prices of the last 20 days.

• Exponential Moving Average (EMA): An exponential moving average (EMA) is a type of moving average (MA) that places a greater weight and significance on the most recent data points. An exponentially weighted moving average reacts more significantly to recent price changes than a simple moving average simple moving average (SMA), which applies an equal weight to all observations in the period.

Trading Strategy

The EMA is useful for crude oil due to the fast-paced market. One effective strategy involves the Moving average crossover or cross-below technique.

Example Application:

We can experiment with different combinations of EMAs, but we’ve found that the 20 EMA and 60 EMA are ideal. This strategy can be applied across various timeframes – daily, weekly, or hourly. However, since this is a trading product, we recommend using it primarily on the hourly chart for optimal results.

In the chart above, I’ve applied two Exponential Moving Averages (EMAs): the 20-period EMA and the 60-period EMA, on an hourly time frame. The strategy here is straightforward: a sell signal is triggered when the 20 EMA crosses below the 60 EMA, and a buy signal is generated when the 20 EMA crosses above the 60 EMA. This approach effectively captures price movements in crude oil, with clear directional shifts following each crossover and cross below.

This strategy isn’t limited to crude oil alone—it can be effectively applied to other commodities, equities, and various timeframes. We strongly recommend rigorous backtesting and forward testing to refine and master this approach. Consistent application and testing will enable a deeper understanding of its effectiveness across different market conditions.

(The author is a Commodities Research Analyst at Axis Securities)

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)