Now is one of the most traded commodities in the world and is taken by many traders, from the novice traders to the experienced timers who have spent years trading. Such a task is trading in crude oil, which is certainly not easy to do since the commodity market is faced with many factors, such as geopolitics, supply and demand imbalances, and even natural disasters that may shift a specific price without strategy to trade in the said market. In this regard, if no strategy is in place, there will be loss or lost opportunities since it will go swinging up and down with the market’s volatility.
These are issues from which the trader needs to extract a reliable strategy with data. The modern trading platform, tools, and access to historical price data, the back-testing software, and real-time market analysis provide these avenues. With modern trading platforms and tools, developers can now make and fine-tune strategies before risking real capital. It is big because back-testing happens to be one of the most powerful tools for how any strategy might perform in the future by analyzing what happened in the past market behavior.
In this lesson, we will cover one extremely simple but very powerful crude oil trading strategy. We’ll then explain why back-testing is, in our opinion, the most important function in the system. Then we’ll discuss how we can take that very same strategy and pit it up against the crude oil market. And lastly, we will take you through some historical backtest results so you have an idea of just how this strategy has faired over time. Whether you just start trading crude oil or refine a strategy to work for you, it is very important that you understand the process of testing and then improving your strategy for ultimate success.
Simple yet Powerful Crude Oil Trading Strategy Building
Crude oil trading is literally the game of simplicity over complication. What follows illustrates one simple strategy which might be implemented and tested for profitability.
25-Day Average Range Calculation
High-low average of a day-by-day calculation over 25 consecutive trading days measure volatility; it is a way to show how many times crude oil trades within its daily range on an average day. This will form the benchmark for that strategy.
Corrected Days
The strategy further limits its trade by requiring it to only occur on specific days of the week. More to the point, the trade needs to be started on either a Tuesday or Thursday. It was used for the following reasons: Previous price action showed that those specific days tend to align the most with producing market conditions favorable to the strategy at hand.
**Step 3: Price Action Trigger
This is a close of the day below the previous day’s close minus the range calculated in Step 1. So far, the strategy has succeeded in creating an entry signal at the beginning of a possible reversal or continuation of a price since the market conditions may be in a trend based on conditions set by the strategy.
**Step 4: Trade Execution
Once this happens, the rule states that you are short by the end of the next trading day. This gives you a well-defined entry and reduces your risk even more as your trade is in tune with established market trends.
Backtesting: Testing Your Trading System
This is where the magic of a trading strategy comes alive in reality. Using charting history, the trader can get a very clear idea of just exactly how a given strategy would have worked out under a wide range of market conditions.
We draw an example and use a Crude Oil Futures Contract as our basis for the backtest of the crude oil trading strategy. Running the strategy over that very same defined period, we could count the profits created by this strategy but also the reliability.
-Number of Trades: 341 trades have been taken during the backtest.
-Average Gain per Trade: 0.25%
Well, though this sounds pretty puny on profits, when compounded over time and over trades, it adds up to very big profits.
Win Rate: 58%
Winning percent is pretty great at 58%; half of the trades were a win; that is, it is a pretty good sign that it is quite sound.
Risk-to-Reward Ratio: Winners are averaging bigger than losers, which makes all the difference in staying profitable over long periods of time.
This output demonstrates how even the most straightforward strategy would impart decent results if well-challenged. Backtesting also reveals a weakness in the strategy and provides a wonderful starting point to continue further optimization.
To my mind, there is no sense for a trader to backtest purposes because it gives an opportunity to evaluate how good the strategy is with historical data. Anyways, there are very good reasons why a trader has to backtest his strategy, especially in this volatile commodity area of crude oil.
- Risk Management Using historical data, you can model trades to understand how long it will take for the strategy to incur a drawdown or loss before eventually being profitable and, therefore creating opportunity through better risk understanding.
- Back testing Performance: It would make him know how it performs under the various conditions of the markets, and he would know if it works or not at times that are most volatile-for example, geopolitical tension or economic downfall.
- Fault finding: Backtesting, therefore, means that you would be in a position to identify whether the strategy can withstand variations of the market or that needs to be upgraded. This therefore saves traders costly mistakes that they would commit in case problems were identified at later stages during live trading.
- Confidence in Execution: Since your strategy has already been tested and tried on actual historical data, you’ll be confident while entering your trades so that you never have this nagging doubt as to what you’re doing. Confidence will enable you to ride out your strategy during unstable market conditions.
Major Things to Consider When Trading Crude Oil
Though the strategy can be traded, there are major considerations that must be taken onboard when trading crude oil.
Market Hours: Though there can be trading in crude oil futures around nearly 24/7 but market hours may at times provide a better time for trading during friendly hours within the day or week. Know market hours at all times and change your trade according to market hours.
Besides, crude oil prices are also pretty sensitive to global events due to decisions of OPEC, the change in US shale productions, and geopolitical tensions across oil-producing regions. So, one needs to keep track of things really closely.
Leverage- This happens to be one of those factors that people really bank on while trading crude oil since this can simply multiply the yields in the trades or simply trigger the loss. Since leverage happens to be a risk factor, proper techniques have to be implemented in the management of the risk after stopping your order at a certain level to avoid losing some capital.
Conclusion: Be a Master Crude Oil Trader by Designing the Right Strategy and Backtesting It
Conclusion: crude oil, as a commodity, is an asset holding much in terms of trading potential, though the market can be quite drastically tricky to navigate when numerous factors influence the price. To trade it successfully, a well-thought-out strategy must be drawn and, most importantly, be backtested with historical data. It does not only fine-tune the strategy but also gives some idea of how such a strategy may perform going forward under the same market conditions.
For instance, the scientific method interacts with broad types of 25 days, selection of specific days of trade, followed by succession of price action triggers, and strict back-testing against results. So, it will make your chance of succeeding in crude oil trades. You remain disciplined all the time as you keep improving your strategy and test your approach before venturing to the actual trades.
It would thus help not only the amateur but even an experienced trader hit bull’s eye in the crude oil market if it encompasses a proven strategy and back-testing of the same.