Financial trading is the same as any other type of trading, simply buying and selling in order to make profit. The difference is simply that what is being exchanged are financial instruments or assets. This can be both cash instruments and derivatives.
The main purpose of financial trading is to make profit, normally by buying low and selling high however with short selling, you can now sell high and buy low without even owning the asset.
Who Trades Financial Markets?
Anyone and everyone can trade the financial markets. The bulk of the volume is done through large institutions such as banks, hedge funds and asset managers.
Millions of companies, governments and private investors also trade financial instruments. With such a large volume and demand, the price of these assets is constantly on the move. The markets that move more provide traders with more opportunities to make profit and are referred to as more volatile markets.
The cryptocurrency market is an example of a market that is highly volatile! As the 2017 chart of bitcoin shows.
Where do you trade financial instruments?
You can buy financial assets one of two ways:
Exchanges – These are organised marketplaces where specific assets can be traded. An example is the New York Stock Exchange.
Over-the-counter (OTC) – This is when two people or parties agree to trade an asset with each other. An example is when you buy directly from a broker or provider.
Types of Trading
As we’ve highlighted trading is simply buying and selling however there are thousands of different strategies that people use. The hardest thing is identifying one that works for you.
Different assets have different factors that affect their price movements.
The forex market is open 24 hours a day, 5 days a week, which is why it is so popular with retail traders because you can hold positions over night and actually put orders into the market at any time of the day.
It is also the most liquid market on the planet, which makes actually buying and selling at the price you want considerably easier than other markets. It simply means that there are more people looking to buy or sell at more prices and explains why you can buy at such small fractions.
Trading Forex is done between two currencies and these can be considered as a major or minor pair. For more information, see our breakdown of the Forex market here.
To trade FX you must have a strategy to do so. This will mean analysing the market and coming up with a decision on the direction of the market – consequently buying or selling depending on your view. There are two ways in which you can analyse a market, using technical or fundamental analysis. Frankly the use of both is usually advised. This will give you a rounder perspective of the market.
In the Forex market, there are a huge amount of variables that can affect the price, ranging from geopolitical to macro and everything in between. A huge driver are interest rates and where the respective central banks sits in their interest rate cycle. Checking forex calendars will give you insight into when these large decisions are and can often identify the times when volatility will increase.
There are several out there but our preferred forex calendar is forexfactory.com.
Commodity trading includes the buying and selling of raw materials. If you are a large corporation then you will likely be trading the physical asset such as actual barrels of oil. However, if you are a retail trader and want to take advantage of the price movements of certain commodities then you will likely be trading a derivative of the commodity. You will normally buy some sort of contract, be it a futures contract, option or a CFD.
You will be buying using an exchange if you are purchasing the commodity as the physical asset or as a futures or options contract.
Commodities as a CFD
If you are buying the commodity as a CFD, you will be buying OTC, which will usually be through a provider such as a retail broker.
Trading commodities as a CFD can have its advantages because, similar to the Forex market, you can trade 24 hours a day, 5 days a week. Another advantage is that the liquidity is higher because the brokers have essentially created a separate market that sits alongside the underlying commodity market.
When you buy an oil CFD, you are not contributing to the oil market but the oil CFD market, which runs parallel to the actual oil market. You therefore have the liquidity of the underlying asset as well as the CFD market and lets traders get the prices they want, with reduced risk of slippage.
Trading Futures Contracts
Futures contacts must be traded on an exchange. Exchanges are third parties that marry up buyers and sellers. Futures trading is normally done by institutions or experienced private traders. Those that are new to trading rarely trade using a futures contract.
The reason the futures market caters for experienced traders is because the minimum price of the contracts are high, or at least high compared to the mini lot sizes you can trade on brokerage platforms.
This basically means that there is more at risk, which is why we recommend beginners stay away from these until they have the funds and experience.
Futures contracts can give easy access to financial markets. Recently there has been the introduction of a bitcoin futures contract, which now allows larger institutions to access the cryptocurrency market without having the risk of using unregulated cryptocurrency exchanges. (Also a reason I think we have seen the volatility in the cryptocurrency market reduce since the beginning of 2018, but that’s a different topic).
Stocks or shares are traded on the stock market, which is an exchange that opens during the day in the market’s respective country. The London Stock Exchange opens from 08:00 until 16:00 Monday to Friday. This is the period you can do business on that exchange.
To begin you will need a stock brokers account. These are relatively easy to open nowadays and can all be done online. Each broker will offer a certain amount of stocks to choose from and although you can manage your account at any time, if you were to buy a stock out of market hours, it would place an order at your preferred price once the market opens.
One of the biggest benefits of trading and owning stocks is that you are due a dividend. An ordinary share is the most common security and represents ownership in a company. This means that when a company does well and makes profit on a yearly basis you are due some of that profit. As a share holder you will be paid a dividend every year normally, meaning that not only can you profit from speculating on the price but also on the success of the actual business.
Like most asset classes nowadays you can buy stocks in CFD form. This often offers leverage on the product meaning you don’t need to put the full position down and can in fact increase profits, although CFDs can be dangerous because they will also leave you exposed to higher risk.
Those who actively trade real stocks will normally have a large fund behind them because for them to buy a stock outright and make profit on the day or week of price movements, they would need to see a huge swing before they made any real profit. Therefore to make money on the percentage movements of a stock they would need to buy a lot of stocks in that business. Making that small margin on a lot of stocks would result in a better profit.
If you take Apple as an example, you could buy one share at $200 and it move $15 in a day, meaning that you could potentially make $15 profit… Not that much in the scale of things. However if you buy 100 shares costing you $20,000, you could make $1,500 profit.
This is why lots of beginners will choose to trade stocks as a CFD, because you would not need to put that full $20,000 down. Depending on the leverage offered you could put a fraction of that down to make the same amount.
Whilst it is easier for beginners to get started with CFDs, there is a large risk when trading them and so it is advised to be properly educated before jumping in.
An index is a collection of assets. The most common are stock indices, you would have heard of some of the most famous ones; FTSE 100, S&P 500, Dow Jones (DJIA), DAX, Nikkei 225.
Trading indices can often be seen as slightly safer than trading individual stocks, this is because you are not open to the risk associated to individual stocks. When you buy an index, there are all the other stocks to counter balance any negative moves.
For example if you had bought the NASDAQ 100 (the top 100 technology companys in the US) and some Apple shares, should Apple run into some bad news, like a bad new batch of Iphones need to be recalled, that would result in a large swing lower in the stock price and ultimately in your investment. If you own the NASDAQ 100, Apple may have had a really bad day/week/month/quarter but you have 99 other stocks that can counter balance that poor performance. In fact should the others completely out way Apple the index can rise and you can make profit despite Apples poor performance.
There are other examples of index trading, for instance you can buy an index of the US dollar, which comprises of various other currencies against the dollar, these include:
Euro (EUR) – 57.6%
Japanese yen (JPY) – 13.6%
British pound sterling (GBP) – 11.9%
Canadian dollar (CAD) – 9.1%
Swedish krona (SEK) – 4.2%
Swiss franc (CHF) – 3.6%
How to Trade
There is no specific way to trade, it is simply trying to buy low and sell high or vice versa. Understanding where you should buy and sell is the difficult thing.
Figuring out where to buy and where to sell is essentially your strategy, your trading strategy. You need to make a decision then when it comes to entering and exiting the market. To make this decision you need to think that the market is going to go in the direction you want it to.
To think that a market is going to go in one direction will come from analysis and there are two forms of analysis; fundamental and technical analysis.
The final two things to consider when you’re trading is how to manage your risk and a traders psychology. Arguably one of the biggest mistakes new traders make is not managing their risk correctly, which ultimately leads to significant loss of funds.
A traders psychology can play a huge role in their success and decide whether they can stick to their trade plan and strategy.
Technical analysis is when you use data to make an educated decision. Most beginners will use technical analysis because it is a quick way to get an understanding of a market and you can set pre-determined rules should certain criteria be met.
This criteria will often give the trader a buy or a sell signal and tell them to enter or exit the market.
Technical analysis normally comes in the form of charting, whereby a market a plotted on a chart against time and you can see how it has previously moved in the past.
The logic is that markets move in patterns based on human behaviour, therefore they repeat themselves. If a market repeats itself you can potentially predict the next movement.
There are hundreds, if not thousands of technical indicators that can help a trader make a decision on the direction of the market, the problem is that lots will send opposite signals and will therefore confuse the trader. With so many indicators on the market, which one do you choose?
There is no correct answer to that however what you need to know is that you will always lose at some point. The idea is to lose less than you win. If you were to take the exact same trade 100 times, would you end up coming out with a profit or a loss? That is the question you need to ask when doing your technical analysis.
The best thing you can do is find a way of analysing the market that gives you buy and sell signals, once you get a signal, you need to take that trade EVERY time. If you don’t take the trade once, it may affect your average and in turn your results.
As highlighted technical analysis is great for beginners because it gives a black and white picture to either buy or sell. The issue is when a trader uses too much and it starts becoming a grey picture. See our technical analysis page for more insight.
Fundamental analysis is the bigger picture. This is how everything can affect the financial markets, from macroeconomic data to political decisions to natural disasters. It all plays a role in affecting the price of different financial markets.
This is our opinion of what separates the good traders from the great traders. Having an understanding about what is going on in the world that can affect the market you want to trade can only give you an advantage when taking a trade.
Forex rates are heavily dependent on the interest decisions of a central bank, therefore if you understand the central banks stance on interest rates and where they are likely to go in their next decision you will have a good idea about what you should or should not be doing in that market.
Fundamental analysis is a way of assessing whether an asset has intrinsic value. Understanding the bigger picture will give you a view on the asset and where it should or should not be trading. If you feel that the asset is considerably undervalued then you would look to buy it until the point you think it is at its correct value according to your analysis.
A trading strategy is a way that a trader makes a decision to buy or sell a certain asset. This can be a combination of technical and fundamental analysis or simply using one of them.
There are thousands of strategies out there, most traders have a strategy that suits their personality and one that they understand and trust.
As long as you know that a strategy is not bullet proof and that you will have bad trades, it then becomes about having faith that the strategy works and over time will make profit.
For more information about trading strategies and for a look at some of the most popular strategies see our trading strategies page.
Psychology is often thought as the most important thing when it comes to trading. Can you stock to your trade plan or strategy?
Humans are prone to specific psychological biases – procrastination is a good example. These biases can make us act in a way that can be bad for our wealth.
People are also not rational, they often act in an surprisingly irrational manner and make predictable errors in their forecasts. The fact of the matter is that you could learn everything their is about economics and how the financial markets work and still lose money because of the decisions you make.
Understanding your own psychology is massively important and should not be overlooked when you make a financial decision.
Risk management is another key aspect that beginners often over look when they start trading. All they will see are the dollar signs ahead and ignore the potential losses that the markets can incur.
If you do not properly manage your risk, you again can know everything there is about the markets and yet still lose money.
The best traders understand capital risk and are not afraid to lose money. A combination of risk management and good psychology is the basis of any great trader.