Volatile oil prices have thrown financial markets into turmoil recently with oil-producing economies the hardest hit.  The plummeting prices have had knock-on effects internationally with the likes of the Russian ruble suffering heavy losses, inflation being pushed lower and bond yields falling globally.  

According to OPEC's monthly oil market report for March 2015, the latest preliminary data for January 2015 shows a slightly increasing year-on-year trend for the top four leading European oil consuming countries.  Losses in demand for fuel oil and gasoline were more than offset by gains in demand for jet fuel/kerosene and LPG.

However, expectations for 2015 oil demand in the region remain unchanged since the previous month with potential towards the upside as the economy seems to be improving for most countries, and as a result of the low historical baseline.

Underscoring the severity of the oil-price pressure, oil companies have already slashed spending, with many of them cutting jobs; and they are also turning to investors to help them preserve cash. But it’s not just big international companies that need to take measures to protect their finances during this period of uncertainty in the oil market.  Self-directed investors should also consider hedging investments or diversifying portfolios to protect against market volatility.

Diversification and Hedging
One of the strategies for reducing exposure to risk is to diversify an investment portfolio. By focusing on just one or two investments investors are exposing themselves to high risks if the market is to suffer from sharp losses, as it happened during the global financial crisis of 2007-8.
By diversifying, investors spread the risk across their investments so that if one market or investment suffers a loss, the other investments will shore up the portfolio so that overall the value of the portfolio remains stable, or, even better, in profit.
 
The challenge is how to diversify successfully so that if one market falls, the other investments remain strong.  One option is to invest in CFDs, also known as Contracts for Difference.

CFDs are a derivative product which allow investors to take a position in the market and trade live market price movements without needing to own the underlying asset.  Investors realise a gain from CFDs trading by predicting whether the underlying asset will rise or fall in price.  There is a huge range of CFD assets that are available for trading including commodities, stocks, indexes and funds.

One of the most appealing characteristics of trading CFDs is the flexibility they offer, specifically the fact that investors can take advantage of both upward moving prices by “going long” and also downward moving prices by “going short”.  This means that even when the price of an asset is declining, such as what we have observed in the oil markets recently, there are still opportunities for savvy investors to benefit.

Another feature of trading CFDs is that you can trade smaller lots than if you were purchasing the asset.
It is important to remember that while trading CFDs with the added benefit of leverage does offer the potential for higher returns, it can also mean that losses can be magnified and investors must trade with caution.  

Many investors use CFDs within their investment portfolio to hedge or protect the trades they are in against sudden and unexpected drops in price.  For example an investor may choose to have the majority of their investment portfolio made up of shares and have a smaller percentage as CFDs.  In this case the shares would be considered a longer term investment with the expectation being that these will bring steady gains over time.  Meanwhile the flexibility that CFDs offer, where buying and selling is rapid and relatively low cost, means that they can be used to shore up the investor’s portfolio in case of the market rapidly moving against expectations.

As we have seen with the price of oil in January, the financial markets can be volatile and prices can change quickly which is why it is critical that all investors take the necessary steps to educate themselves on the product and ensure they understand all the benefits and risks to trading an instruments.
Source: Saxo Bank