E7 STRUCTURES

Introduction

When you first look into financial trading, it can be confusing. You're likely to hear a lot of jargon surrounding it. However, the core principles are generally simple once explained.

  • Financial trading is the buying and selling of financial instruments.
  • There are many types of financial instruments, including but not limited to shares, indices, forex and commodities.
  • Mostly financial traders trade to make a profit not to own the underlying asset.
  • Financial markets are places, physical or otherwise, where buyers and sellers come to trade.
  • The markets are regulated by different institutions in different regions of the world to reduce fraud and improve efficiency.

Stock indices

  • A stock index is a measurement of value of a certain section of the stock market like technology.
  • Major stock indices can give an indication to the health of a section of the market and or economy of a particular country or region.
  • Most nations have one major index. Others like the USA have more, in this case three, that is the Dow Jones Industrial Average, S&P 500 and NASDAQ-100.

Forex 

  • Forex is how individuals and businesses convert one currency to another.
  • Forex, also known as foreign exchange, FX or the currency market, is the largest financial market in the world.
  • On average over an estimated $6 trillion ( soon to be over $7 trillion ) worth of transactions take place every day.
  • That's around 100 times more than the New York Stock Exchange (NYSE) the world's biggest stock exchange.
  • The main players in the forex market are major international banks.
  • In forex, speculation represent the vast majority of transactions.
  • It's an over the counter (OTC) market, that is to say, trades take place directly between two parties not through an exchange.
  • Forex is traded in pairs, when trading a forex pair you are simultaneously buying one currency while selling another.
  • The first currency in every pair is the base or primary currency. The second is the quote or counter currency.

What is a pip?

  • Unlike share price movements, forex movements are measured in very small units called pips.
  • For example, if the EUR/USD price moves from 1.21050 to 1.21060, that 0.0001 USD rise in value represents one pip.
  • One important exception to this is where the yen is the counter currency. 
  • Here it is the second decimal place instead of the forth which is classed as one pip.
  • Forex movements are measured in pips. For most pairs, a pip is a one digit move in the fourth decimal place of the price.
  • Unlike Spread betting trading, in CFD trading, forex is traded in standard lots, which represent 100,000 units of currency.
  • Currency pairs are usually classed as Majors, Minors, Australasians, Scandinavians and Exotics.
  • Generally, the stronger the economy of a country, the stronger its currency will be.

Commodities

  • Commodities are physical assets that are mined, farmed or extracted from the earth like Wheat or Gold.
  • They can be soft commodities (agricultural) or hard commodities (energy and metals).
  • They are traded on either the spot or futures market.
  • The spot market is generally for buyers and sellers of the physical commodity, while the futures market tends to be dominated by speculators and hedgers

Market participants

  • Retail traders are private individuals who buy and sell financial instruments using a personal account.
  • A broker is an authorised intermediary who executes trades on traders behalf and may also give them advice.
  • An exchange has a central physical location where brokers and dealers come together to buy and sell. Although technology is changing this in many ways.
  • OTC markets are traded via a virtual network of broker-dealers.
  • A market maker provides liquidity by holding an inventory of a particular security and quoting continuous prices to buyers and sellers.
  • Institutional traders manage large pools of money and trade the financial markets on behalf of individual investors.
  • High frequency trading (HFT) uses technology and complex algorithms, to place vast volumes of ultra short term trades and thus capitalise on brief market fluctuations.

Basic order types

  • An order is an instruction to buy or sell a market instrument.
  • A market order will be executed immediately at the best price available, provided there is sufficient liquidity.
  • A market order may be filled at a worse price than the current desired price.
  • A limit order is an instruction to trade if a market price reaches a desired level more favourable than the current price.
  • A stop order is an instruction to trade if a market price reaches a particular level less favourable than the current price.
  • Using a stop loss ( SL ) on a trade will restrict your losses if the market moves against your intended direction.
  • You can use a stop entry order to open a new position if a market hits a desired price level.
  • A trailing stop is a special type of stop loss that moves in tandem with favourable changes in the market price, helping to protect your profits.
  • For an order to be filled, there must be sufficient buyers or sellers in the market to take the other side of your trade, this is liquidity.
  • In certain circumstances your order may not be executed exactly as you want. 
  • If a market order can not be filled at the desired price, it will be executed at the next best available price.
  • For instruments that are traded on an exchange, prices are sourced from an order book.
  • For assets traded OTC ( over the counter ), prices are sourced from providers participating in the market.
  • Slippage occurs when markets are moving rapidly and the price you want becomes unavailable by the time your order is executed.
  • You can put an absolute cap on your losses by using a guaranteed stop, although there is usually a charge for this. So check with your broker. 
  • Leverage enables you to gain a large exposure to a financial asset using a small amount of your trading capital.
  • You need only put up a fraction of the full value of your position, known as a margin, with the provider effectively lending you the balance
  • Leverage magnifies both profits and losses, and these can exceed your initial deposit into a trading account. However, the best brokers tend to provide negative balance protection, which stops you owing a broker money if you lose more than what is in your trading account.
  • It's important to use proper risk management strategies and keep in mind the full value of your trade, its potential for loss when using leverage.
  • If a leveraged position moves against you, you may get a margin call from your broker asking you to top up your account with extras funds. Failure to do this in a timely fashion usually results in automatic closure of any current open trades.
  • Leveraged trading can be regarded as riskier than traditional trading.