Financial markets are a crucial part of today’s financial system. Without them, the world wouldn’t exist as we know it today and companies would have fewer opportunities to raise capital, grow and invest in research and development of new products. Let’s take a look at what financial markets are and how they can be traded.
What Are Financial Markets?
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As Phillip Konchar, Head Tutor at the online financial trading course provider My Trading Skills suggests, “Markets are where we buy and sell products, financial markets are where we buy and sell financial products.”
A financial market is any marketplace in which people trade financial instruments, such as stocks, bonds, precious metals, commodities, currencies or derivative contracts. You can often read the term exchange in the media, which is sometimes used to describe a market. However, exchanges are a narrower term than markets and refer to organised places where financial trading occurs, such as the New York Stock Exchange or the London Stock Exchange.
While an exchange can be a physical location, like the stock exchanges mentioned above, there also exist electronic exchanges, such as NASDAQ. The trading of bonds and currencies is mostly performed over-the-counter between two persons or organisations which agree on a specific price. However, some bonds can also be traded on a stock exchange.
Types of Financial Markets
In finance, the term “financial markets” often refers to the activity of raising finance and can be broken down into two main types: capital markets, which are used to long-term financing, and money markets, which are used for short-term financing.
The mainstream use of the term refers to financial markets on which various types of securities and asset classes can be traded. In this regard, financial markets can be divided into:
- Stock markets, which are used to raise capital through the issuance of company stocks and to trade stocks which are already issued.
- Bonds markets, which provide debt financing through the issuance of debt instruments such as bonds or commercial papers and the trading thereof.
- Money markets, which are used for short-term debt financing through instruments with maturities that range from one day to one year. Bear in mind that money markets are not currency markets (Forex).
- Derivative markets, which are used to trade derivative contracts such as futures and options. These markets are often used to manage financial risk.
- Foreign exchange markets, or Forex, are used to trade currencies over-the-counter.
- Commodity markets, which facilitate the trading of various commodities such as oil, gold and agricultural products.
Trading Stocks on an Exchange
One of the most common ways to trade financial markets is by trading stocks on an organised stock exchange. Many people invest in the stock market for various reasons, either to speculate on short-term price movements or to build an income for their retirement in the long-term.
To trade stocks on a stock exchange, such as the New York Stock Exchange or London Stock Exchange, you’ll need to use the service of a brokerage house which acts as an intermediary between buyers and sellers. If you place a buy order with your broker, the broker tries to match your order with a sell order on the exchange that offers the best possible selling price and charges you a commission for the service.
Most companies also pay out dividends to their stockholders, depending on the financial standing of the company and anticipated future expenses (e.g. in the research and development of new products.) To receive a dividend payment, you need to buy the stock before the ex-dividend date, which is usually set one business day before the record date. If you buy a stock on its ex-dividend date or after, the seller of the stock receives the dividend.
While the purchase of physical stocks on a regular stock exchange has certain advantages, the trading of financial instruments through CFD contracts is becoming increasingly popular among short-term retail traders. CFD refers to Contracts for Difference, which are derivative contracts that track the price of an underlying financial instrument, such as stocks, stock indices, currencies or commodities.
When trading on CFDs, you’re not the actual owner of the underlying instrument. The CFD contract is designed simply to track the price of the instrument, returning a profit or loss on the difference between the opening and closing price of your trade.
Still, there are notable advantages of trading CFDs, such as the availability to trade on high leverage and to short-sell an instrument in anticipation of lower prices in the future. Trading on leverage refers to trading on money borrowed from your broker, which can be used to substantially increase your market exposure by allocating a relatively small portion of your trading account as the “margin” for the trade.
Short-selling, on the other hand, refers to the selling of financial instruments borrowed from your broker and, once the price falls, the repurchase of the borrowed instruments at a lower price in order to return the borrowed instruments to the broker. A short-seller makes a profit on the difference between the selling and buying price.
In this article, we explained what financial markets are, covered the main types of financial markets and mentioned two popular ways to trade on them. Financial markets are places on which the exchange of financial instruments takes place and can be usually grouped by the type of instruments which are traded on the market, such as stock markets, commodity markets and bond markets, to name a few.
While buying stocks on a regular stock exchange has certain advantages, such as the collection of dividends if the stock is bought before its ex-dividend rate, CFD trading is becoming increasingly popular in the last few years. When trading on CFDs, you don’t own the underlying asset as the contract is only designed to track the price of the asset. However, CFD brokers usually offer relatively high leverage and the possibility to short-sell financial instrument, which can be used to profit even in bear markets.