Financial markets are any marketplace where people trade financial (intangible) assets with each other. They are critical to the smooth day-to-day operations of many capitalist economies – the US, EU, Australia, and many other economies around the world.
Regarded by many as a specialist’s concept, trading and investing in the financial markets can be time-consuming, difficult, and oftentimes causes confusions. This guide aims to clarify the process of learning, entering, and trading the financial markets.
Part 1: Trading The Financial Markets: What’s In It For Me?
Before diving into the gritty details of the financial markets, it is crucial to understand the underlying reason(s) why someone would consider participating them. Why does trading take place?
Here are three main motives that drive the trading activities between market participants.
1. Financial Management
This motive involves operations and strategic management of a trader, oftentimes are business operators. For example, the producer of an agriculture commodity e.g. rice, wheat, sugar, coffee, etc. can enter into a derivative contract to buy/sell the very same commodity that he is producing. The strategic reason behind this motive is to protect (hedge) against any price fluctuations affecting his commodity, to reduce the uncertainty surrounding his future business operations and profitability.
Traders can enter the financial markets to quickly realize profits, if his or her mandate is pure speculation. In fact, this is the most common motive behind most retail traders like you and me. If we expect the price of a financial product (asset) is undervalued (cheap) and will likely appreciate, we will enter a speculative long position, or buy that asset before its value increases further. Alternatively, if we believe the price of an asset is overvalued (too expensive), we will enter a speculative short position (sell) of that asset before it depreciates.
Most centralized (traditional) markets give traders the ability to enter long positions only. On the other hand, OTC market (decentralized) allows traders to enter long and short positions simultaneously.
Most clients do not have direct market access (DMA) to the financial markets, which requires a prime brokerage account. Yet, many institutions and sophisticated traders have the financial resources and human capital (trading strategy) to trade on a large scale.
Therefore, it is a motive to perform trading for those clients that requires DMA. This generates spread profits i.e. difference between highest bid and lowest ask for the trader. Prime brokers offer liquidity solutions that enable clients capitalize on generating profits on a large scale, while managing their risks effectively.
Upcoming Part 2: Trading Commitment – What Is Your Starting Level?