Oil investing; You better know this before you buy this investment

earth-drowing-in-oilOil stocks have been making nice gains over the last year, and have been doing even better over the past quarter. Is now the right time to buy or what? This article will quickly explore what the markets are saying, because stock price alone does not necessarily indicate a good buy.

If you were to merely try and chase recent performance you would find out quickly that it’s not very profitable. Instead, you should develop an investment plan, understand who you are investing in by analyzing company fundamentals and technical, and gather an understanding of what the markets are saying.

Below, you can clearly see that oil companies have been doing very well over the past year. However, this maybe misleading as we will discuss.

oil stocks

The fact is, traders are currently paying big dollars in the options market to protect against a massive plunge in oil prices expected later this year. Why is this? There has been a huge increase in reserves as consumption hasn’t matched supply. Moreover, the US alone has over 14% more oil reserves than we had a year ago.

Currently, the price per barrel of oil on this 23rd day of September, 2009, is hovering around $71. Put options, or the right to sell, show the most popular put option for December was to sell oil at around $60 per barrel, with the second most popular option to sell at $50 per barrel. What does this mean? Traders are expecting a big drop in the price oil.

Having said the above, the short term outlook would mean that oil is actually a bad short term investment at this time. A major drop in the price of oil would clearly cut into profit margins of the major oil companies and would have an adverse affect on their stock prices. However, over the long-term that might not be the case. Many argue that economic growth is the name of the game, the price of oil is more closely related to future expectations of it’s need to sustain an economy.

It’s important to understand what has driven the price of oil up to its current price after the bubble popped and the price per barrel drop to its most recent low where the price per barrel was around $35. Most attribute the doubling in price as being tied to economic stimulus spending – which will eventually slow as those projects are completed. You’re depending on the economy to keep it’s current pace and or increase it’s output substantially in order to keep the price growing. However great this may sound, it’s probably not too realistic.

Something else to keep in mind when looking at the price of oil is how the dollar affects its price. The price of oil will climb as the dollars loses its value against international currencies. As the dollar gains value, the price will lower.

So where do you go from here, since oil just doesn’t seem to be the greatest short term investment? We know you won’t like this answer – but if you’re new to investing – you have to understand – the best advice for you is to help you understand; the answer truly depends on your risk tolerance and how your portfolio is setup – ensure you have a diversified portfolio. At this point, we would recommend finding those companies with good fundamentals and lower stock prices. Chasing recent performance just doesn’t make cents.

If you’re new to all of this, a great place to get started understanding investing is in our lessons located on the drop down bar above.

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