What is natural gas and how do you trade it?
Rebecca Cattlin November 10, 2021 10:30 PM
Natural gas is one of the most widely traded commodities on the market due to its use as a global source of energy. Find out everything you need to know about natural gas and how to trade it.
What is natural gas?
Natural gas is a naturally occurring hydrocarbon, formed deep beneath the earth’s surface. We use natural gas for producing power, heating houses and for industrial production purposes. It’s known as one of the cheapest, cleanest and most naturally abundant fossil fuels.
However, due to its gaseous form, natural gas has to be transported via pipelines or converted into a pressurised liquid to be transported overseas. So, while it’s a cheap energy to produce, it can be costly to create the infrastructure needed to export it.
It’s one of the most common energy sources in the world, which has made it one of the most popular commodities among traders. The market is known for its volatility, which creates an exciting but risky environment.
How to trade natural gas
There are a few different ways you can trade natural gas. The most popular are futures, options, and via stocks and ETFs.
When you trade natural gas with us, you’ll be using derivatives to speculate on the market price of futures, stocks and ETFs. You won’t ever take ownership of the underlying asset, but instead, you’ll take a position on whether the market price will rise or fall. Your profit or loss will depend on how far the market moves in your favour or against you.
Natural gas futures
Natural gas futures are contracts in which two parties agree to exchange a certain amount of natural gas at a set price on a set date in the future. At the point of expiry, the trader would either receive the physical delivery of natural gas or settle their position in cash.
If prices rise beyond the agreed upon price, they would be able to buy natural gas for the lower price, but if prices fell, they’d have to buy natural gas at a higher price. The idea is that companies and investors can lock in a price ahead of time, effectively hedging against market movements that could negatively impact them.
Natural gas futures are based on delivery at the Henry Hub in Louisiana, which is where multiple US pipelines converge. The contracts are worth 10,000 million British thermal units (MMBtu) of natural gas. Natural gas futures provide the basis for most other derivatives.
Learn more about futures trading
Natural gas options
Natural gas options are also a derivative, and as with futures, they enable traders to buy or sell natural gas for a set price on a set expiration date. But unlike futures, options holders can choose whether or not to execute their contract upon expiry.
There are two types of contracts: calls and puts. You’d buy a call option if you thought the price of natural gas was going to rise, and you’d buy a put option if you thought it would fall. If the price of natural gas goes beyond the set price – known as the strike price – the option is in the money and can be executed for a profit.
Learn more about options trading
Natural gas stocks
Natural gas stocks are units of ownership in companies involved in the sector. Transporting natural requires a pipeline, which means the companies involved in the building of infrastructure are some of the most popular natural gas stocks. Other big players include exporters and producers.
Examples of well-known natural gas stocks include BHP Billiton, Antero Resource Corp and Enterprise Products Partners. It’s worth noting that a lot of ‘natural gas stocks’ will likely also give you exposure to other energies, such as crude oil. This makes it important to understand what each company does, and which factors will influence its share price.
Learn about trading shares
Natural gas ETFs
Natural gas ETFs are financial instruments that enable traders to get exposure to a basket of assets from a single position. You can trade ETFs that hold natural gas futures or shares of companies involved in the industry.
Examples include the:
- WisdomTree Natural Gas 2x Daily Leveraged, which is designed to replicate 200% of the daily change in natural gas futures contracts by tracking the Bloomberg Natural Gas SL index
- iShares STOXX Europe 600 Oil & Gas (DE), which tracks the performance of the STOXX Europe 600 Oil & Gas Index as closely as possible by investing in physical index securities
- SPDR S&P Oil & Gas Exploration & Production ETF, which seeks to provide returns that correspond to the total return performance of the S&P Oil & Gas Exploration & Production Select Industry Index
How to invest in natural gas
You can invest in natural gas by buying the shares of companies involved in the industry and ETFs that hold natural gas-linked assets. Unlike trading, you won’t be able to speculate on falling prices, but you would be able to earn additional income if the companies paid dividends.
As investing in natural gas doesn’t necessarily give you direct exposure to the market, you’ll need to be aware of the other factors that can influence your investment, such as company earnings, supply chain disruption and so on.
What impacts natural gas prices?
Natural gas prices are driven by supply and demand like any market, but due to its core role in the economy, the commodity can be subject to drastic price swings depending on whether there’s a period of growth or decline.
Here are some of the other major factors that impact natural gas prices.
- The level of natural gas production – when production levels increase, prices tend to decrease as the commodity becomes more readily available and natural market competition works to reduce prices for consumers
- How much natural gas is in storage – when there’s a high volume of natural gas in reserve, it usually means there’s plenty of supply and low demand, so the price will be driven down. Should storage facilities get too full – as oil storage did in 2020 – it could cause panic due to speculative investors not wanting to accept delivery of any assets bought
- Severe weather events – these can interrupt production and are particularly damaging during winter (when demand for heating is highest) and summer (when there’s a need for air conditioning). High demand and low supply will drive prices up
- Availability and prices of other fuels – as the transition to cleaner energy starts to take place, it’s believed that natural gas will be used to ‘bridge the gap’, which could see demand rise. In fact, the International Energy Agency sees natural gas demand rising 29% by 2040
Natural gas trading strategies
While it is possible to open longer-term positions on natural gas, the vast majority of natural gas strategies utilise trading styles that have much shorter timeframes. The most popular are day trading and swing trading.
However, your strategy and style will depend on the goals you’ve set out in your trading plan. While you can take inspiration from other traders, it’s important to create your own strategy that’s suited to your risk appetite, lifestyle and available capital.
Day trading natural gas
Day trading is the practice of opening a position on natural gas and closing it before the end of the trading day – ensuring that no overnight movements impact your position. As a short-term trading style, it’s a popular way to speculate on the price of natural gas due to the high volatility in the market. The aim would be to make smaller, but more regular profits, from multiple positions taken throughout the day, rather than a single buy and hold trade.
Day trading does come with a greater time commitment than longer-term methodologies, as you’d have to monitor the market all day to ensure your strategy is successful. Most day traders will use take-profit and stop-loss orders that ensure their positions are closed at the levels laid out in their trading plan.
Swing trading natural gas
Swing trading is a short-to-medium-term style of trading that attempts to profit from natural gas price movements over a period of a few days to several weeks. Swing traders would attempt to enter a position at the bottom or top of a move and capture the ‘swing’ higher or lower. To do so, you’d use technical analysis to identify support and resistance levels in the natural gas market. Popular methods include using indicators such as Fibonacci retracements and simple moving averages.
How do you trade natural gas reports?
You can trade natural gas reports by anticipating whether the data will have a positive or negative impact on the market price. The most commonly watched reports are the Weekly Natural Gas Storage reports from the US Energy Information Admiration. If storage capacity increases, then demand is likely rising, and market prices will rise too. If storage capacity decreases, then it’s a sign supply is higher than demand and prices could fall.
What unit is natural gas traded in?
Natural gas futures are traded in million British thermal units (MMBtu). However, some countries measure it in Gigajoule and natural gas reports show units as Bcf, which is the abbreviation for billion cubic feet of gas.
What are natural gas trading hours?
Natural gas trades 24 hours a day from 6pm Sunday to 5pm Friday (ET), which is 11pm Sunday to 10pm Friday UK time. There’s a trading break from 10pm to 11pm (GMT).
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