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Energy Invested

April 27, 2020
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Well, did everyone go out and get their free oil? Who knew commodities could go into the negative? There were a lot of retail traders on Robinhood that didn’t, but they are what professional traders call “liquidity”. For those sane people who pay zero attention to financial news, I am referring to oil futures trading in the negative for the first time in history. This led to many jokes about getting paid for oil or getting free gas at the pump. Unless you have an oil tanker you may have been disappointed.

So, what is a futures contract anyway? Commodities, such as oil, gold, or frozen orange juice, have a price that you can buy them at today. However, if you are an airline and sell plane tickets for trips happening in three months how do you know how much to charge per ticket? If oil prices doubled between now and when you take your airplane to get a fill up, you would have charged too little for the ticket. If, however, you entered into a contract with someone to buy oil in three months at a specified price then it wouldn’t matter what oil prices did between now and then. You can sell your ticket at the appropriate price and give me leg cramps and stale air for free. A t-shirt company might do this with cotton, a cereal company with grains, or my kids with memes. That is the very basics of a futures contract.

It has been written about a million times before but there is a difference between being an investor and a trader. With zero commissions and free stocks for referrals it is very easy to become a trader. There is nothing wrong with trading, but you need to understand what it is you are doing. If all you want to do is play the stock market, then think of that money as the casino money you take with you to Vegas. It’s fun money you didn’t get by cashing out little Johnny’s college fund to pump dollars into a machine. You should not be day trading your long-term investments.

The difference between investing and trading becomes very important in the futures market. Businesses use futures contracts to hedge risk, like spikes in oil prices, but they are not the only ones that trade in futures. There are plenty of speculators that trade futures to win big in the market. They play an important role in the operation of the market but they are there to gamble. If you are trading futures, and you are not hedging some underlying risk, understand that you are gambling. Unless you are a sophisticated trader, I would not suggest trading futures. Unfortunately, you can get exposure to futures contracts without knowing it if you are not paying enough attention to what exactly you are trading.

Case in point is retail traders getting absolutely hammered by trading an oil ETF that rolls over futures contracts month to month. Know what you are getting into when you trade on a retail platform and try not to be someone else’s liquidity.