It’s difficult for most newbie traders to understand the pricing mechanism of the trading instruments. So, while trying to predict the direction and price movements of the trading instruments, they treat it as a casino. Eventually, they lose money and would also face financial collapse. Let’s discuss financial instruments here.
A trading instrument is an asset and is the subject on which trading operations are carried out. A currency pair, security, physical goods, derivatives, etc. are examples of trading instruments. It is an asset through which transferring value between buyers and sellers takes place.
a) Currency Pairs
In the last decade, currency pairs have become the most trading tool for online trading. It is carried out in the international market, and a lot of brokers provide online service. In trading, while buying a currency pair a trader buys the base currency and sells the quote currency. Among the currency pairs, the pairs containing the American dollar have more liquidity, and the pairs are called ‘majors.’ Other currency pairs that don’t contain the American dollar are called ‘crosses.’
Unlike forex trading, which is over the counter market, stock trading is regulated by state agencies. A trader has legal protection and can legislatively challenge in the event of fraudulent actions on the part of brokers. The predictability of price movements is easier in the case of stock markets. It is due to a much smaller number of participants, and also it depends on a finite number of variables. In the stock market, a trader should have a large amount to get a significant return as the leverage provided is very less than the forex market. But the risk involved in the larger assets is comparatively smaller than the forex market.
CFD – “Contracts for difference” has become a popular trading instrument in recent years. It’s a good cost-effective instrument available when compared to the expensive stock instrument. A CFD trader tries to guess the direction of the price movement of the asset he chooses. And wants to make profits on the price difference between the current and future points in time. A CFD trader avoids the possible administrative costs but also loses benefits like dividends, voting rights, etc. as the owner of the shares.
d) Depositary receipt
It is a certificate, the investor gets in the form of security. And it provides ownership in the form of a certain number of shares in a foreign company. Among the depository receipts, the American Depository Receipt and the Global Depository Receipt are the popular ones. These receipts are mainly traded in the European markets. Using depository receipts reduces the amount you spend as commissions.
e) Mutual funds
It is based on a registered security document that certifies the investors’ right to receive the amount. And the investor could get the amount based on the current value of the unit he bought. When taking into account the trading volume, the mutual fund comes next to stocks and bonds. The easy accessibility to private investors and the chances of making high profits are the advantages of mutual funds. But it also has a higher risk level when compared to fixed income securities and other guaranteed investment instruments.
Until now we have discussed the basic trading instruments. There is another group of instruments called derivatives. In fact, a derivative is a security whose value depends on the value of one or more assets. The assets commonly used in derivatives are stocks, bonds, commodities, currencies, interest rates, and market indices. Futures and forward contracts, options, and swaps are some of the typical derivatives.
g) Futures contract
It is used by the traders to fix the certain value of the asset at a certain point in the future. In purchasing futures contracts, the traders bet on the value of the asset over a certain period of time. It is mainly used in the stock market and the quality and quantity of the asset are fixed at the time of buying the contract. The futures contract is executed at the end of its validity, and the trader makes a profit if the value of the underlying asset exceeds the value of the futures.
h) Forward contracts
It is not a standardized one and is an over the counter trading instrument. In the execution of a forward contract, only real delivery of goods is carried out. And no transaction of value is carried out. So, forward contracts are mainly used by enterprises to handle the fluctuations in the prices of goods.
It is a financial instrument that allows the buyer/ seller to buy/ sell at a predetermined price. The traders get to carry out the buy/sell action in a certain period of time. Mostly, binary options brokers offer this financial instrument.
Each trading instrument has its advantages and disadvantages. So, it is the skill and requirements of the trader that decides the financial instrument he chooses. But becoming a professional trader takes a long time and the traders should have the patience to sustain their efforts. Endure, save your capital, learn the nuances of the trading instruments, and be successful in your trading.