Which fundamental and technical indicators to use for oil trading?

Economic indicators

In terms of economic indicators, it is particularly important for oil trading to monitor GDP (Gross Domestic Product) and PMI (Purchasing Managers' Index), especially for large economies such as the US, China, Japan, Germany, etc.

The reason for tracking these indicators is that if an economy is growing rapidly, it is likely to consume more oil, hence the demand for oil should increase, which should push the price of oil upwards. Otherwise, if the economy is heading into recession, the reduction in demand should lead the oil price to fall.

We have the impact of the PMI on the oil price in Chart 2, where Brent crude is on the 5-minute chart.
 

_{Brent crude oil on 5 min chart after China PMI reporting}

The chart shows the situation when China reported PMI information on March 1, 2023. This data was significantly better than expected. Immediately after the report was released, oil moved up quickly as the strong economic data indicated stronger economic growth after periods of contraction due to covid measures.

Technical indicators - moving averages and stochastic oscillator

Technical indicators are a tool that sends you a signal about the possible direction of the trend, whether an instrument is too expensive and therefore its price could fall, or whether it is too cheap and therefore its price could rise, etc. Of course, you need to remember that all indicators are based on history, which means that they are somehow lagged. Nevertheless, they can be of some help to sort market data into groups and thus provide a clearer interpretation of the market situation.

Moving averages can be used to determine the direction of the oil trend. A stochastic oscillator can be used to determine whether oil is too expensive (and therefore overbought) or too cheap (and therefore oversold) within an identified trend. It is preferable to combine both of these indicators.

In chart 3 we have an example of using these indicators to trade oil on the H4 chart.
 

_{WTI crude oil on H4 chart with moving averages and stochastic oscillator}

The moving averages are the EMA with a period of 50 (red line) and the SMA with a period of 100 (blue line). In the case when the faster average, i.e. EMA 50, falls below the slower SMA 100, it is a signal of a bearish, i.e. downtrend. Otherwise, when the faster average EMA 50 is above the SMA 100, then it is a signal for an uptrend.
 

In the chart above, you can see that the SMA 100 moving average has acted as support in the case of an uptrend or as resistance in the case of a downtrend. If a trader chose an entry strategy after the SMA 100 is hit, he would have 4 trading situations, 2 trades long and 2 trades short.
 

At the same time, we can see that the stochastic indicator fell below 20 when oil reached the SMA 100 in an uptrend. And in the case of a downtrend, the stochastic reached above the 80 value when the price touched the SMA 100. From this, a trading strategy can then be built:

• Enter long when the price on H4 is at SMA 100 and before that, the stochastic was at 20. Enter long when the first bullish candle is formed. Once this occurs, the entry is at the opening of the next candle.

• Enter short when the price on H4 will be at SMA 100 and before that the stochastic was at 80. An entry short is when the first bearish candle forms, i.e. at the opening of the second candle.

Then the trader only deals with risk management and money management rules. In terms of take profit, it is advisable to set it to the nearest area of support and resistance, i.e. it is a mistake to speculate on a breakout of this area. The stop loss is then placed below the low of the given formation for long trades, and above the high of the formation for short trades.
 

We see that in the cases of trades 1, 3, and 4, the profit would always be at least 1:1 relative to the risk. And the maximum profit when taking into account the take profit to the nearest resistance or support areas would be approximately 2.5R in the case of trade 1, 2R for trade 2, and 3R for trade 3. Supposed the one R (the stop loss value) is 1% of the account balance, then the minimum profit would be 3% and the maximum profit would be approximately 7.5% for that trade in less than 3 months.

Situation number 2 should not be traded because it is a disadvantageous risk/reward ratio, as the take profit when set to the nearest resistance gives a lower profit than the risk taken.

Even though the above examples worked out reasonably well, there are bound to be situations where the strategy fails because the indicators give false signals as well as good ones. Therefore, it is a good idea to test situations in your platform yourself when the strategy does and does not work. At the same time, you need to think about what risk management rules to adopt so that the strategy makes sense in the overall context of not only good signals but also false ones.

Trading Oil with Purple Strike Indicator

The Purple Strike indicator is another way to identify a trend and enter a trade at its inception. It is an indicator that we have developed specifically for our clients and that you should already have installed in your platform.
 

_{Brent crude oil on H1 chart with Purple Strike indicator}

The signal in the long direction is shown by the blue color of the indicator, the red color shows the signal in the short direction. One way to trade this indicator is to enter a trade on the next candle after the signal occurs. Exiting the trade is then at the time the opposite signal arises or when the risk-reward of 1:1 is reached, whichever comes first.

At point 1, a short signal has occurred, stop loss above the previous high. At point 2, a long signal, stop loss below the last low. In both cases, the 1:1 risk reward would also be hit.

But you can also see that there are situations where the indicator sent a false signal and the trade would have failed. This is because the indicator is particularly suitable for trading an uptrend or downtrend. In case of a sideways trend, it gives false signals. However, some oscillators can be used for trading a sideways trend, for example, the already mentioned stochastic.

Conclusion

Oil trading is very interesting because it combines multiple contexts that resemble a puzzle. The advantage is that this information is always publicly available. It is up to the trader to interpret the information correctly. In any case, fundamental information on the state of stocks or OPEC policy is a major factor that moves the market. The conclusions of technical analysis then reflect this situation in some way.

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