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.
- 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 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 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
- 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.