Financial trading: what is it all about

What is Financial trading?

The term, Financial trading, can be confusing if you hear a lot of jargon surrounding it, such as dividend, commodity, bonds, interest rate, swaps, broker, etc. Actually, financial trading is similar to dealing in physical goods and services in a wholesale or retail marketplace and more like bidding in an auction market. Very similar to bidding at eBay site.

What actually is a financial instrument?

Financial instruments are monetary contracts between two and more parties. They can be created, traded, modified and settled.

The financial instruments can take many forms, but some of the main categories are:

Shares - small units of ownership in a company, such as Alibaba, HSBC, Facebook, Google, Amazon and Apple

Indices - the value of a group of companies, represented as a single number, eg the Heng Seng Index, S&P 500, Nikkei 225, FTSE 100,

Forex - global currencies, including the US dollar, Euro, Japanese Yen and Pound.

Commodities - physical assets like gold, raw materials like oil, and agricultural products like wheat.

Whatever the instrument being traded, the intention is always to make a profit. For this , you have to buy low and sell high. Such buyers are said to be taking "Long" positions or even known as bulls.

If you sell it for a price lower than your buying price, you make a loss.

Can you sell what you don't own? Short Selling explained

The major difference between buying and selling of physical goods and financial assets is that you can sell assets that are not currently owned. You can borrow and sell them hoping to repurchase them at a lower price than what you have sold for.

The act of selling what is not owned is termed "Short Selling" or "Going short".

Often the seller will "borrow" or "rent" the items to be sold mostly from their broker, and later repurchase identical items for return to the lender. The act of repurchasing is known as "covering" a position.

Who is doing the trading?

In financial markets, millions of companies, individuals, institutions and even governments are all trying to profit from buying and selling financial instruments at the same time.

This means that the prices of those instruments tend to constantly be on the move. A market that moves a lot is known as a volatile market. These markets bring more opportunities for profit, but also mean increased risk.

What is being traded?

As against physical goods, financial trading involves the buying and selling of financial instruments, for which an auction-type market is created by both buyers and sellers, who are also called Market Makers.

Where does trading take place?

Financial instruments can be bought and sold in one of the two ways:

They can be traded on organised and regulated marketplaces, called Exchanges, where a particular instrument is bought and sold . Hong Kong Stock Exchange is an example of such a marketplace.

Financial instruments can be traded over-the-counter (OTC) as well, when two parties or more agree to trade instruments with each other (like when trading Currency Options with a bank.)

What is an auction market and why it is important for financial trading?

The use of auctions can be traced back to 500 BC in Babylon. The modern use of auctions can be found anywhere in real life: government procurement, government land sales, property sales, foreign exchange, stock exchange, future market, property sale, eBay, ad auction, etc.

Are markets driven by forces of supply and demand?

In an auction market, buyers enter bids and sellers enter offers at the same time. The auctions show markets are not driven purely by forces of supply and demand or the real value of the instruments as against their perceived value.

The market is also moved by belief or sentiment as well and this is where new traders have to understand the sentiment part.

Imagine that four buyers want to buy a share of company XYZ and make the following bids: $10.00, 10.02, 10.03 and $10.06. Conversely, there are four sellers that desire to sell shares of company XYZ, and these sellers submitted offers to sell their shares at the following prices: $10.06, 10.09, 10.12 and $10.13. In this scenario, the individuals that made bids/offers for company XYZ at $10.06 will have their orders executed. All remaining orders will not immediately be executed, and the current price of company XYZ will be $10.06.

Irrational beliefs and expectations can as well drive the markets

Bitcoin is a classic example of where people are buying it for the sole reason that the price is rising . What is its intrinsic value? Nobody knows. But the price is being justified by a rational buyer under the belief that it can be resold later to another party who is willing to pay an even higher price.