NEW YORK -- Of all the news bulletins and rumors that have jerked oil prices up and down over the past five months, perhaps the most bizarre swept through the oil market on Oct. 22.

It was a story that Iraqi leader Saddam Hussein had dreamed that the prophet Muhammad had urged him to withdraw his troops from Kuwait. Mixed with other unverified reports that day that seemed to point toward peace in the Persian Gulf, it caused a panicky cascade of selling by oil traders, pushing the price of crude oil down a record $5.41 a barrel.

In the new world of oil, even the barest scraps of information can trigger trading stampedes.

To critics, who have watched oil prices more than double since Iraq's Aug. 2 invasion of Kuwait before falling part way back, the market's vulnerability to sharp price changes is its great vice.

"You've got this crazy system of pricing without regard to supply and demand," said Sen. Joseph I. Lieberman (D-Conn.), a leading congressional critic of the oil market. "Do we really want a system where a bunch of young guys screaming in a pit in New York set the price of oil? ... It's just not good for the rest of us. People see an opportunity to make money, so they're coming in to make money at our expense."

In a sense, traders say, Lieberman is right. The price of oil, set in open trading by "Wall Street Refiners," has come to reflect far more than simply supply and demand calculations. It has become the product of a wide array of economic and psychological forces, and of the interests of the thousands of participants in the market.

A refiner looking for a barge-load of crude oil, a speculator playing the latest rumor out of the Persian Gulf, a trader in the crowded "pits" of the New York Mercantile Exchange, a Wall Street broker consulting esoteric charts of price performance, an Oklahoma wildcatter hoping to lock in a price for crude to be pumped out of the ground months hence -- each of these is in the market, buying and selling, at any given time.

The push and pull of the forces that they exert is reflected from minute to minute in the price of oil. As a result, this market, which over the past decade has replaced the oil industry's traditional, secret pricing deals, is seen by many participants as the fairest mechanism for pricing one of the world's most important commodities.

"It's as clear a marketplace as you can put together," said Frank G. Zarb, the former federal energy czar who is chairman of the Wall Street brokerage Smith Barney & Co. "I don't know a better way to do it."

The principal public trading arena of the oil traders is the New York Mercantile Exchange, or Nymex, at the World Trade Center in lower Manhattan. It is a "futures" market, where traders buy and sell contracts obligating them to acquire or deliver fixed quantities of crude oil at specified dates weeks and months in the future. While the delivery date is distant, the trading on those contracts does not stop until the date has virtually arrived. Oil also is traded informally among companies on the "spot" or "cash" market.

The futures price, displayed on computer screens for traders and brokers around the world, is the benchmark for pricing most of the oil that will be refined into gasoline and heating fuel.

Over periods of many months, the futures price of oil reflects nothing more or less than the fundamentals of current and expected oil supply and demand, the market's defenders say. "In order to trade fundamentally, you've got to be able to stand the noise," said longtime trader Cynthia Kase, a vice president of Chemical Bank in New York. The "noise" is the clamor of rumors and news that often drives the market's daily activity.

For traders whose customers are in the market for the long term -- who want to lock up prices for oil months in the future -- the minute-by-minute noise is irrelevant.

But for traders in the pits and oil brokers like Tom Bentz, the ability to accurately predict the course of the market over the next few minutes -- to say nothing of the next few months -- can be the difference between being successful or becoming, in trading-pit slang, a "hood ornament."

Most of the day, Bentz can be found at his desk, a phone at each ear and two more in front of him. Computer screens are flashing numbers and charts of oil-price patterns. Cable News Network is blaring from a TV nearby.

"News drives the market, so you keep your ears open," said Bentz, the trading director of United Energy Inc. In his office a couple of blocks from the Nymex, Bentz buys and sells oil futures contracts for customers including big oil companies, independent oil producers, Wall Street trading companies and just about everybody in between. "I try to keep an idea of what's going on," he said.

News and rumors aren't the only things that influence traders' decisions to buy and sell. They also consult esoteric charts showing patterns of price movement with names like "Japanese candles" or "Elliott waves" that many traders believe predict which way the market will move. They may also trade on information about other companies' supply and demand positions.

The herd instinct of the market is often overpowering. One afternoon last month, a report -- later proved to be unfounded -- swept the market that Kuwait had offered to give up two strategically crucial islands to Iraq in exchange for Iraq's withdrawal from the rest of the country.

Almost instantly, the normal hubbub of the oil trading pit on the Nymex turned into an uproar, with traders shouting and jostling for positions and giving the arms up-palms out gesture that signals a desire to sell futures contracts. Whether they knew the reason for the selling spree or not, they joined it. No one wanted to be left out of a major price move. "What you're seeing," one trader said in an aside, "is a crash."

Within five minutes, the price of a barrel of crude oil had dropped 75 cents. But it then ticked up again just as quickly, driven now by a fresh report that President Bush was continuing to take a hard line against Iraq, regardless of the purported Kuwaiti offer. The same brokers who had been selling a few minutes before turned their palms inward, signaling that they wanted to buy. Simultaneously, at oil-trading desks all over the world, the sell orders of a few minutes before were being switched to buy orders as traders followed the action in the Nymex pits on their computer screens.

The brokers could have held on to their contracts when the price started to fall, waiting for it to go back up. But that is a risk few will take. When the price is falling, the brokers want to get out and get their clients out. They may not know the reason for the decline, but one glance at the price tells them it is happening. The collective selling adds to the downward price pressure, and the converse is true when the price is rising. The key is knowing -- or guessing -- when the turnaround is coming.

Market officials bristle at the criticism that this is sheer speculation at work. "To say that speculation is driving the market -- speculation as it has been used with the connotation of gambling -- is not true," said R. Patrick Thompson, president of the Nymex. "What is occurring, that I think at times has been termed speculation by the oil industry, has been what truly is the function of a futures market" -- to protect against swings in price and availability.

"This is not a gambling hall," said Michael Wilner, president of Hilltop Trading Co. in New York and a veteran of the futures-trading pits. "It's a place to invest and a place to hedge."

"Hedging" is a form of risk management in which the trading in oil futures contracts is used to balance or offset risks of price and supply changes in the "spot" or "cash" market, where oil producers, refiners and users trade cargoes of oil among themselves.

Many Speculate

Veteran traders say that just about everyone in the market speculates to some extent. Many experts say the market has become even more speculative as players have traded more and more aggressively to keep ahead of the rapid-fire changes in oil prices and as non-oil companies have become bigger players in the market.

When the trading is volatile, as it has been since the Aug. 2 invasion of Kuwait, the opportunities for making speculative profits increase dramatically. And thus so does the payoff from a hot tip.

Some of the information gathering would be considered insider trading on the stock market -- pipelines into companies and other entities that may provide a trader with early warning on a critical piece of news that affects the supply and demand for oil. "Sometimes you might hear news before it's news," said Michael McDermott, an oil broker at Paine Webber Inc. in New York. "If there are major problems in the North Sea, we might hear it before it's news."

There is no rule against insider trading in the oil market. If, for, example, XYZ Oil Co. has a major refinery fire and the company chairman sells his XYZ stock before the news is generally released, he can go to jail. But if an XYZ oil trader uses that information to lock in a replacement supply of gasoline before the news pushes the price up, he's considered prudent.

"If I come into possession of a piece of information a little bit ahead of time ... that's OK," said Thompson, Nymex's president.

The oil market is not merely a trading forum, Thompson said. It is also a dynamic communications center that distributes information of all kinds about the oil world, information that is immediately weighed, digested and fed into the calculation of prices, helping make those prices a truer reflection of reality.

Federal regulators agree. "What these prices reflect ... is the amalgamation of what the market participants, and in this case the experts, expect," said Wendy L. Gramm, chairman of the Commodities Futures Trading Commission (CFTC), the agency that regulates trading on the oil market.

Occasionally, some veteran oil market participants say, traders will start rumors for their own benefit, in an effort to move the price one way or the other. Participants in the market say such incidents are rare, not to mention illegal, but they occur.

"It's not unusual for someone to take a position, circulate a rumor,

and then play the knee-jerk reaction," said an experienced trader.

"Whether it's external rumor or planted rumor is always the question," said one market expert. "Look at the pressure on these guys. The pressure to cheat is outrageous."

The 'Chinese Wall'

Leo Haviland said he felt that pressure. Until he was fired in 1989, Haviland was the $600,000-a-year vice president in charge of energy futures at Goldman Sachs & Co., the Wall Street investment bank. Through J. Aron & Co., a secretive subsidiary, Goldman is one of the world's largest oil trading firms.

In a suit against his former employers, Haviland alleges that he was fired because he refused their demands to divulge information about the plans of his Goldman Sachs futures-trading clients that would have been useful to J. Aron's oil traders in the cash market.

Haviland's case is one of the few times a prominent insider has alleged that a major firm sought to breach the "Chinese Wall" that is supposed to insulate the interests of futures brokerage customers from the interests of the oil-trading side of the company.

J. Aron's senior oil trading partners, Stephen Hendel and Stephen Semlitz, declined to be interviewed for attribution for this series of articles on the oil market. But a spokesman for Goldman Sachs called Haviland's accusations "totally false" and said that Haviland decided to "concoct this complaint" because he was fired.

Haviland did not allege that anyone at J. Aron or Goldman Sachs betrayed any client's confidence -- only that they tried to. On the advice of his lawyer, Haviland declined to discuss his case, but he said in an interview that any system in which well-heeled corporations such as Goldman Sachs trade for themselves and for their customers in the same marketplace lends itself to possible corruption.

Thompson said brokers who trade for themselves and for outside clients are required to note on each transaction which account it is for. Computers scan the transaction to see if the traders got better prices than their customers on these "dual trades."

One broker recently was fined $25,000 and suspended for three months for illegal dual trading, Thompson said. "The penalties are very strict and they act as deterrents," he said.

Some brokerages and investment houses, such as Smith Barney and Shearson Lehman Brothers Inc., avoid the potential conflict of interest questions raised in the Haviland case by refusing to trade futures for their own accounts, executing trades only for their clients. Morgan Stanley & Co. takes the opposite tack: It trades oil and futures for itself but has no futures brokerage clients.

"In any company that has multiple divisions, there could be a problem. That's why no one on this desk trades his own account," said John Azarow, senior energy trader at Smith Barney.

The CFTC prohibits "trading ahead," the practice of buying or selling contracts for a broker's own account before executing an order from a client, in order to get ahead of a price movement. Also prohibited is "trading against," or "jumping" a client -- taking a buying or selling position opposite that of the customer. But some insiders say brokers can manipulate the market by trading information with other brokers about their trading strategies.

While Nymex officials and senior traders boast that a system of stringent self-regulation keeps the exchange clean, lists of internal disciplinary actions published in the exchange's biweekly newsletter indicate that even some of the largest and best-known trading companies occasionally run afoul of the rules. Within the past couple of months, according to the newsletters, such large-scale futures traders as J. Aron, Shearson Lehman, Refco Inc. and Chicago Corp. have been fined between $1,000 and $47,000 for a variety of infractions. Dozens of smaller brokers have been fined several hundred dollars each and, in some cases, suspended from the exchange.

Nonetheless, the CFTC regularly checks the market for irregularities, and "from our surveillance perspective, we have not had anything that we have seen that {indicates that} there has been manipulation of the market," said John Mielke, director of market surveillance for the CFTC. "None of the classic things we look for have shown up."

Weighed against the market's hypersensitivity is its value in bringing a multitude of buyers and sellers together, every business day, to vie over the best price for oil, its defenders say. This is the tradeoff it presents.

The market's defenders point to the painful experience of the oil shocks of the 1970s, triggered by sudden embargoes and cutbacks by producing nations that cut supplies short around the world. Uncertain whether they could get the oil they needed in the future, refiners were willing to pay sky-high prices for crude oil. Uncertainty also prompted widespread hoarding by refiners and by motorists who tried to keep their auto tanks full.

During the Persian Gulf crisis, by contrast, the ability to buy oil on the futures market, months ahead of delivery, has provided a vital source of insurance to refiners and helped vent some of the upward pressure out of rising prices, experts say. That prices did increase reflects oil buyers' anxiety about the outcome in the gulf and their fear that the crisis could take a sudden turn for the worse, jeopardizing oil supplies.

But overall, defenders say, the market has produced the fairest possible price.

"The market is always right. I've never seen a price that was obviously wrong. If it were, you wouldn't see trading at that price," said James R. Fiedler, vice president of E.D. & F. Man International Futures Inc., a New York commodities trading concern.

"Without the futures market, the prices would have been a hell of a lot higher," said Jack O'Dea, first vice president for New York energy futures at Dean Witter Reynolds Inc. "You've taken the ability to manipulate prices out of the hands of the OPEC {Organization of Petroleum Exporting Countries} members."

"Without a futures market, you can't see the forward {future} prices. You can only assume that tomorrow will be worse than today. That encourages hoarding," said Andrew J. Hall, president of Phibro Energy Inc., the oil-trading division of Salomon Brothers Inc. "This {system} provides a tremendous incentive to people not to hoard."

Nymex's New Rules

Stung by criticism about the impact of the recent price increases on consumers and the national economy, and moving to head off any further government regulation, the Nymex adopted new rules last month that would cap wild swings in the futures market by halting trading any time the price of a barrel of crude oil for delivery in the following month moves up or down $15 in a single day -- nearly three times larger than the largest price move ever.

But brokers and traders interviewed for these articles were unanimous in saying it would be a serious mistake to close the oil futures exchange no matter what the emergency. They say such a move would create chaos and allow oil companies to set prices on their own, probably higher than would be set in the open market. Hoarding would be encouraged by cutting off access to enforceable futures contracts, they said.

"The idea makes us crazy," said Andrew S. Lebow, a futures broker at E.D. & F. Man.

CFTC Commissioner William Albrecht, like other officials at the agency and the Nymex, argues that the oil market has functioned well in the current crisis, that prices have not been moved artificially and that the system does not need reform.

"We'd all have been happier if {prices} hadn't gone up as much, but I don't know what mechanism you'd put in to keep that from happening," he said. "Fine-tuning is not the problem. The problem is that someone invaded Kuwait."