CMC Markets financial experts share their knowledge of types of financial markets and offer advice on choosing where to trade when using derivatives such as spread bets and CFDs.
With the shock waves of war, the pandemic and a changing political landscape reverberating around the world, there has never been a more important time for traders to choose their markets wisely. Here we are going to take a look at some expert insights on what to consider before trading.
What are the different financial markets?
There are many different types of financial markets, ranging from currencies to commodities and bonds. Each market then has specific subsets. For example, the commodities market is divided into energy, precious metals, and agricultural commodities.
What is the foreign exchange market?
Also known as the “foreign exchange market”, the foreign exchange market is the largest and most active trading market in the world. It is also the most liquid, which means it is the easiest to convert transactions into real money. While forex trading has long been dominated by large global banks and institutions, in recent years it has become increasingly popular and accessible to individual traders.
Currency trading is slightly different from trading other assets. Trading other assets usually involves trading on a market with profit and loss based on absolute returns (unless you are betting on spreads). For example, if you buy and the market goes up, you could make money. If you buy and it goes down, you could lose money.
However, foreign exchange trading is done using currency pairs, where one currency is exchanged for another. Profits and losses are measured by the performance of one currency against another. For example, on any given day, the US dollar (USD) could rise against the euro but also fall against the Japanese yen. In the foreign exchange market, there is no absolute return as there may be in other markets.
What is the commodity market?
In the commodities market, there are two main types of traders: hedgers and speculators.
Hedging is a strategy of opening multiple buy or sell positions at once to reduce the risk of loss and protect your portfolio against factors beyond your control.
A typical example of a hedge trader is a trader who wants to lock in a price for a commodity which he will then use at a future date, using futures or futures contracts. For example, farmers and agricultural businesses may want to set a price for wheat when they deliver it in September. This means that if the price of wheat falls between the time it is planted and the time it is harvested, hedgers are protected against any significant loss.
Speculators, on the other hand, seek to profit from price changes as supply and demand conditions change. They have no intention of delivering or taking physical goods and instead try to predict (or speculate) which direction a particular market is heading and then trade from there. Spread bettors and CFD traders can be classified as speculative traders because they bet on the price movements of financial instruments rather than making a direct investment.
Products tend to belong to the following groups:
- Precious metals and base metals
- Energy raw materials
- Agricultural products
What are treasury bills and the bond market?
The treasury bill and bond market is another active trading market that gives you the opportunity to trade broader economic trends in different countries.
Governments around the world issue bonds or gilts to individual investors, corporations, banks, and even other countries. A bond can be thought of as a government share – you lend them money for government spending, then they pay you back with interest at a later date.
Governments sell bonds at different prices and with different interest rates depending on prevailing economic conditions. Once a bond has been issued, it usually has a fixed interest rate.
In addition to interest payments, government bonds often also pay off with a lottery-like reward system that is drawn monthly. Bond investors can receive tax-free cash prizes of up to £1,000,000 if their name is selected from the pool.
What is the stock market?
Stock trading is what people usually think of when they think of financial markets and investments. The sale of shares from a company’s treasury to shareholders is known as the primary market.
With stock trading, companies sell shares in an effort to raise more money and capital to grow their business. Traders may buy the shares in the expectation that the value of the company’s shares will increase; However, with derivative trading products such as spread bets and CFDs, you can also open short positions or sell the instrument if you expect the stock price to fall, which can lead to profits. equal.
What are stock indices?
Global market indices are the benchmark measure used to gauge the strength or weakness of the market performance of a particular region or country.
A market index assesses the performance of the top companies by market capitalization or share price in a country. This is then used as a barometer of the market performance of an entire country and even to assess the impact of broader macroeconomic trends that can be seen in indices across the world.
Different indices are made up of a different number of companies depending on the country. For example, the FTSE 100 assesses the performance of the top 100 companies in the United Kingdom, while the Dow Jones 30 examines the top 30 companies in the United States.
Some of the most well-known global stock indices include:
- FTSE 100 (UK)
- Dow Jones 30 (United States)
- Hang Seng (Hong Kong)
- DAX (Germany)
- CAC 40 (France)
- IBEX 35 (Spain)
- OMXS30 (Sweden)
- FTSE MIB (Italy)
How to choose the markets to trade in
Understanding financial markets and deciding which ones to trade is undeniably complicated. However, you should consider a few different factors that can help simplify the process, as well as risk management protocols.
For example, most traders start their journey by trading in a market they are familiar with before looking to diversify into international markets or assets they are less familiar with.
Then, once you have started trading in a familiar market, you can try taking small steps into a similar area. For example, you can choose to expand trading from individual stocks to stock indices or from resource stocks to related commodities.
You also need to keep an eye out for broader macroeconomic trends (such as war or fuel supply) and smaller shifts that are only happening in a handful of niche markets. Balancing the small picture with the big picture is a key skill for any budding investor and spotting the relationship between small trends and big trends can lead to some very smart trades.
Derivatives trading involves a number of risks, such as financial market volatility and the potential for capital loss, so it is important that you also consider how to combat these. For example, traders often place tools such as stop-loss and take-profit orders on positions after considering how much they are willing or able to lose. Even markets that some traders consider relatively safe, such as the bond market, can present opportunities for losses, so it’s important to always be prepared.