More and more people are attracted to trading on financial markets. But the problem is that the world of financial markets can seem rather complex. That's why we are bringing you a series of articles aimed at complete beginners. In these, we will summarise the very basics. Today let’s answer a seemingly simple question - what are financial markets?
The world of financial markets and trading is alluring for many due to the potential for financial and time independence. While it may seem like anyone can become a successful trader, the reality is that it requires a significant amount of effort and education. However, for those who are committed to learning and continuously improving their skills, trading can become not only an interesting hobby but also a viable career path.
At Purple Trading, we strive to make this journey easier for our clients by providing them with webinars and ebooks that cover the fundamentals of trading and financial markets. If you're considering embarking on this journey, this article series is the perfect starting point. We'll begin with the most basic question: what are financial markets?
So, whether you're a beginner or an experienced trader, keep reading to learn more about the exciting world of financial markets and how you can potentially achieve financial freedom through trading.
A financial market is a platform or network of platforms that allow the purchase or sale of financial assets (stocks, bonds, currencies, commodities). Financial markets are populated by sellers and buyers who trade assets according to their assumed price determined by the laws of supply and demand. In the global economy, financial markets play an important role by enabling companies or governments to raise capital by allowing individuals to buy their stocks or bonds with a view to future profits.
Equally, however, financial markets allow investors to buy and sell among themselves. Therefore, in the case of securities trading, we speak of 2 types of financial markets:
This is the financial market where securities (such as stocks or bonds) are issued first in an IPO (initial public offering). In this case, the issuers of the securities are directly companies or governments, who hope to raise the necessary capital by selling them to investors. Depending on the type and quantity of securities held, these investors then have the opportunity to exercise rights (but also obligations) and receive, for example, dividends or participate in the company's general meeting.
In the secondary financial market, existing securities or assets are sold and bought. The secondary financial market is, therefore, a place where investors meet to buy and sell among themselves - without the participation of issuers. If you have ever watched a movie or series with a financial market theme, it was most likely set in the secondary financial markets. One of the secondary financial markets is, for example, the New York Stock Exchange (NYSE).
Financial markets are subject to a somewhat more sophisticated structuralization in academic terms than we will describe here today. However, if you want to get at least a basic idea of what you can trade in the financial markets, the breakdown described below is quite sufficient.
We have already described this market above. It is where companies issue their shares to the public and institutional investors who can then buy them (on the primary financial market) or hope that their price will rise and sell them to other investors (on the secondary financial market).
This is a financial market where investors buy and sell bonds. These are securities that oblige the issuing party to pay the buying party (the new bondholder) a pre-agreed amount, including interest if it is due. In addition, all this must take place within the term specified within the bond. Thus, bond issuers are usually certain municipal units (states, counties, municipalities) or corporations that need to secure a quick capital receipt.
Of all the financial markets, the Forex market is by far the largest. “What is Forex?” you might be asking. It is a decentralized financial market where foreign currencies are sold and bought. Several trillion dollars flow through it daily. The Forex market is home to the big players, i.e. national central banks, hedge funds, and multinational corporations, as well as small retail investors, including clients of Purple Trading and other brokers. While the big players use Forex mainly for hedging as an effective form of protection from loss, retail traders try to speculate on the future likely price development of currency pairs.
This is a market where materials such as gold, oil, and agricultural products are bought and sold. Although it is indeed possible to buy commodities in physical form (e.g. 1000 barrels of oil), this is not an activity that would be of interest to small or large investors. Trading on commodity markets is thus mostly carried out within the framework of so-called futures contracts, which allow traders to speculate on the future price of commodities and thus make a profit without having to physically deliver the commodity. The commodity market can thus often be sought for the purpose of diversifying an investment portfolio. On the other hand, among producers, futures contracts are widely used for hedging.
This is a financial market where investors trade financial instruments whose price is based on the price of an underlying asset (stock, commodity, currency, etc.). Thus, if you trade gold in the form of a derivative, for example, and you place a buy order, you are only speculating on the increase in its price, which is based on the actual price of gold in the commodity market. If you give an order to sell, you are speculating on a decline. In neither case are you, and never will be, the direct owner of the actual underlying asset (in this case gold). Common financial instruments in the derivatives markets are CFDs, Futures or Options.
Although each of the markets and trading methods described above has its pros and cons, the derivative markets are probably the most widely used trading method among retail investors. There are several reasons for this, ranging from the possibility of leverage to the fact that one can speculate in both directions, to the lower financial burden on the investor. But the main reason is probably the fact that in the derivatives market, you can find instruments derived from all the types of markets mentioned above.
Read more about the benefits of CFDs
We have already mentioned roughly what financial markets are for and what investors go to them for. Now, let’s talk about how financial markets work
When a retail investor wants to buy or sell a financial asset, he places a trade order in the market. In order to place this order, the investor needs a broker. The broker serves as an intermediary between the buyers and sellers in the market and helps pair their orders so that the trade occurs. In exchange, the broker charges a fee, which may be added for example per traded volume (this fee is called a commission) or added on each trade (in the form of a spread). However, there are other types of fees.
Financial markets are influenced by a wide range of factors. These include macroeconomic indicators, news from the business world, geopolitical developments, and government or central bank regulations. But it can also include the weather (especially in the case of commodity markets). All of these factors can mess with the balance of supply and demand and thus affect the final price of a traded asset. For example, these Chinese indicators affect the price of oil which makes them interesting for all oil traders. Stock traders, on the other hand, will be more focused on monitoring US labour market data, for example.
Successful trader never stops learning. That is why we have created the Purple Academy where you can find interesting articles, knowledge-expanding ebooks and detailed trading turorials. So if you are interested, just dive in and start learning! (It’s free).
Last but not least, financial markets also play an important role as an indicator of the vitality of the global economy. Strong and rising stock market prices, for example, signal optimism about the future development of the global economy. Conversely, falling stock market prices may indicate a slowing economy, which in turn affects oil prices, which tend to fall during a crisis (remember the negative oil prices during the coronavirus epidemic). In short, everything is interconnected, and you are unlikely to find a sector today that is spinning on its own as a lone cog in the whole clockwork machine that is the global economy.
Now that we have explained what financial markets are, how financial markets are divided and how they work, it is time to talk about the different financial market entities. That is, which participants move in financial markets and what impact their movements have on the markets.
Here we find individual traders and investors who pursue their own interests by acting in the financial markets. This can include so-called retail investors (anyone who opens a trading account with a broker and takes up trading as a hobby), but also professional traders with portfolios worth several million dollars.
Among these financial market subjects, we find large organizations that invest capital on behalf of their clients. These include pension funds, hedge funds, mutual funds and insurance companies.
These financial market players are by far the largest, and the extent of their impact on the market corresponds to this. Their aim is to issue financial assets (shares, bonds) to raise equity capital. Corporations and governments also use financial markets to manage the risk associated with currency fluctuations or to invest surplus capital.
Financial market players, which include institutional investors as well as corporations and governments, are known among traders as "Big Players". In addition to private sector players, this includes central banks and sovereign wealth funds. All of these financial market players have sufficient capital to ensure that their orders can influence the balance between supply and demand in the financial market and thus the overall price of the financial instrument.
There are therefore many trading strategies that teach you to analyze the behavior of the big players and use this to your own advantage.
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