Choosing the Market that Best Fits You.
A Quick Financial Adviser Guide to the Main
Financial Markets in Existence
One of the most important decisions that new traders need to make is choosing
the financial
market that bests fits their own trading style. In fact, outstanding differences
exist among the stock,
options, ETFs, futures and forex markets both in terms of risks involved and
trading possibilities
that each one of them has to offer.
The Stock Market
Because of the attention it gets from worldwide media on a daily basis, the
stock market is
undoubtedly the best-known by the general public. Emerging companies usually
enter the market to
raise capital, letting investors acquire a portion of their business that
traders later try to resell to
third parties for a profit. The rate at which traders buy and sell stocks
determines their value on the
market; factors that push traders to buy or sell stocks include quarterly
revenue reports, new
products, rumors, and general news regarding the company.
Because of the large number of companies listed on each stock exchange – NASDAQ
alone
lists over 3,200 of them – a player in the stock market will usually manage to
closely monitor only a
few dozens of companies. This can limit the trader's profit opportunities or,
even worse, push
unexperienced traders to diversify their portfolios by investing in companies
that they haven't
researched properly, which can expose them to significant risks.
Another risk associated to the stock market is market manipulation, the practice
by company
investors – often within the company itself – to take actions aimed to increase
or decrease the value
of a stock in order to buy or sell at a profit.
The Stock Options Market
A stock option is a contract between a buyer and a seller that gives the buyer
the right, but
not the obligation, to buy (“call option”) or sell (“put option”) an asset at a
later time at an agreed
price. If the buyer chooses to exercise this right, the seller is forced to sell
or buy the asset at the
price written on the contract. The underlying asset can be a piece of property,
shares of stock, or
even a futures contract (see below).
Exchange-traded options are an important class of options that have standardized
features,
which are being adopted to make trading on public exchanges easier; but options
can also be traded
over the counter (OTC) between private parties.
One of the main advantages in trading stock options is the reduced risk when
compared to
other markets. In fact, there are several mathematical models that try and
describe how the value of
an option will change in response to certain events, often with surprising
accuracy. This makes the
risks associated with options trading quite low for the trader who has learned
to correctly apply
those models to his own investment strategy.
The Futures Market
A futures contract is a contract that obliges its owner to buy or sell a
standardized quantity
(“lot”) of a certain commodity at a certain date (“delivery date”) in the
future, at a price (“settlement
price”) determined when the contract was stipulated.
The main difference between options and futures is that while the owner of an
option is
under no obligation to fulfill his end of the deal, both parties in a futures
contract are forced to do so
on the settlement date. To exit the commitment before the settlement date, the
holder of a futures
contract would need to hedge his exposure by either selling a long position or
buying a short one.
The ETF Market
ETFs, or “exchange-traded funds”, are securities traded on the stock exchange
market that
hold assets such as stocks or bonds. ETF traders benefit from the
diversification that is typical of an
index fund while also being able to sell short, buy on margin and purchase as
little as one share at a
time. Their low costs (compared to mutual funds) and tax efficiency also
contribute to make them a
choice for a growing number of investors.
An ETF trades at approximately the same price as the NAV of its underlying
assets and
tends to track an index, such as the Dow Jones Industrial Average or the S&P
500.
Common criticism to exchange-traded funds include that they often represent
short-term
speculation and that most of them don't provide enough diversification. Some
analysts also claim
that ETFs can and have been be used to manipulate market prices, particularly
through short selling.
The Forex Market
With an estimated daily trading volume of $3.2 trillion – 30 to 50 times the
volume traded in
the entire US stock exchange – the forex (“foreign exchange”, or “currency
trading”) market is by
far the biggest financial market in the world. Forex is an highly leveraged and
highly liquid market
that is open 24 hours a day, 5 days a week and is currently experiencing an
unprecedented boom
because of its unique characteristics.
Opening a trade in the forex market means buying a lot (100,000 units) in a
first currency
while selling a second one at the same time; when the trade is closed, the two
currencies are being
sold and bought back respectively. The trader's profit depends on how the ratio
between the two
currencies changed in the meantime.
With reliable and high speed Internet connections becoming more and more common
around
the globe, forex brokers soon started offering their services online, where
clients can trade directly
from a web-based interface and enjoy commissions that are typically very low (spreads
only).
Unfortunately, because of the very high leverage – up to 400:1 – that brokers
usually offer
their clients, many unexperienced traders are led to believe that they can
comfortably start trading
on this market even with a very low starting balance, without realizing that
high leverage can (and
most certainly will) work against undercapitalized accounts in the long run.
BEST REGARDS FinancialAdviser.Net Jim Hansen Financial adviser
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