Introduction to financial markets
Introduction to financial markets
Financial markets are places where people and companies come to buy and sell assets like stocks, bonds (debt), commodities and other products.
People have traded on financial markets for hundreds of years and they grew out of a very real practical need – to help people buy and sell things more efficiently, and to help companies that needed money to raise it more quickly.
Over the years, markets have grown bigger and faster. More people than ever before are now able to get access to these markets. Once they were the preserve of big banks, finance houses and very wealthy individuals, but no longer.
Types of asset classes
Traders are able to access a wide range of financial markets but what are the main markets available and how do they work?
Made up of a basket of shares, a stock market index can be traded like an individual share. By buying and selling indices, traders can speculate on the changes in price of the biggest companies in a single market. For example, the US 500 is one of the most widely traded indices globally – it is a measurement of some of the largest and most actively traded companies listed on the New York Stock Exchange or NASDAQ.
Also known as Forex or FX, the currency markets represent the constant exchange of currencies between banks and other market participants. Currencies are quoted as a currency ‘pair’ – for example GBP/USD is the value of US dollar to the pound. All currencies have a three letter code. The currency markets, unlike many other markets, are open 24 hrs.
Also known as share markets, these represent the prices of shares in companies that are listed (quoted) on major stock exchanges. Famous examples include Apple, BP or Microsoft.
Many commodities are resources that are eventually consumed, for example oil or wheat. Most commodity markets fall in energy – like natural gas or crude oil, softs – like soybeans or wheat, and metals, like gold, silver or platinum. Each commodity market will have its own particular cycles, determined by specific factors like harvests or energy demands.
Bonds are debt instruments issued by government which pay interest to investors, and which can also be traded. Popular bond markets include the UK and US government 10 year bonds.
Interest rates are set by central banks and represent the cost of borrowing for currencies controlled by those banks. The interest rates of the UK, US and Eurozone rates are frequently traded.
What affects the markets?
Market prices are driven by the supply and demand for goods which can be affected by a broad range of factors. Here are some of the most common:
- News: Many market participants keep tabs on news in real-time; bad news affecting a company or a country will drive prices down, for example. Even political news can have a wide-reaching effect on markets
- Central bank policy: Central banks make decisions such as setting interest rates, and these can have a profound effect on the flow of money around the world, and will have a big impact on markets
- Company results: Companies listed on stock exchanges will release regular results which will encourage investors to buy or sell their shares
- Government data: Governments will release data which will move markets, like unemployment information or inflation data for example
There are a wide range of people and companies that trade in financial markets.
- Institutional investors: Pension funds, asset managers and mutual fund providers participate in financial markets to make profits for themselves and and their customers
- Banks: Banks act like brokers for other companies, like fund managers. They used to do plenty of trading themselves, but new regulations mean they have less scope to trade their own book.
- Brokers: Specialists placing trades for their clients
- Market makers: Some institutions are tasked with selling shares or bonds into the market. Their job is to get the best price possible for their clients. For example, if a company decides to issue more shares, a market maker is given the job of selling them into the market.
- Retail investors: Everyday investors can participate in financial markets through investing in funds, buying shares, or actively trading the markets through CFDs
How are financial markets traded?
Typically, markets can be traded in two ways:
In the past, these were actual buildings where brokers met to buy and sale shares in companies, or other assets, like corn or livestock. Now most trading on exchanges takes place online, with orders being placed from all over the world. Trading on exchange means that contracts are standardised with a clear guidance on the quality, quantity and when you will receive the goods.
This is where two parties agree to buy/sell to each other directly, without trading on an exchange.