Understanding the Different Types of Trading Instruments

Although trading regular spot forex is considered one of the most popular and potentially profitable ways of generating returns in the financial trading markets, there are numerous other financial instruments available, which investors should consider when making portfolio decisions. Investors that consider a choice of financial instruments can increase their trading opportunities, while also diversifying their trading portfolios. However, it is necessary to understand how the various available trading instruments work before starting to trade.

Stocks

Stocks are securities which are issued by a corporate entity. These securities, also referred to as “equity” or “shares,” indicate proportionate ownership in the corporation issuing the stock. Owning a share entitles an investor to a proportion of the assets and earnings of the issuing company. Shares can be bought and sold on stock exchanges. Price movements of stocks are determined by various factors, including macroeconomic reports, company financial reports, changes in the executive management team of the company, alterations to the business models, mergers and acquisitions and more. Some examples of stocks include Facebook, Google, Apple and more.

Bonds

A bond is an investment instrument which is essentially a loan made by the bondholder to a borrower. This is usually a government or corporate entity. This fixed-income investment instrument is a loan agreement which includes specific terms, such as the date when the principal amount is to be paid back to the owner of the bond or investor. Also, the terms, like any other type of loan, will include interest payments made by the borrower. The interest rates can be either fixed or variable.

Commodities

People have been trading commodities since the beginnings of human civilization. Trading commodities is the buying, selling and bartering of physical goods, such as gold, silver, oil, copper, agricultural products and more. Nowadays, people trade commodities using futures contracts via exchanges.

The two types of commodity futures traders are those that make or take physical delivery of assets, and speculators who never intend to take or make delivery of physical commodities. The first type of trader uses commodities futures contracts to hedge against future fluctuations in commodity prices. For instance, a corn farmer will hedge against the risk of loss if corn prices fall before the harvesting of a crop that has already been planted. The farmer will be able to sell the corn futures contracts to ensure a price for the corn when it is finally harvested. On the other hand, speculators will trade in the commodities futures exchanges to profit from price fluctuations as well as to diversify investment portfolios.

Indices

An index in the financial trading markets is a group of securities which represent a specific market or a particular segment of a market. For example, stock and bond indices are hypothetical portfolios of securities that represent specific market segments and industries, such as real estate or healthcare. The US Aggregate Bond Index and the S&P 500 are commonly referred to indices for the US bond and stock markets, respectively.

Investors cannot trade indices directly, but instead, use exchange-traded funds (ETFs) and mutual funds which are portfolios of securities which attempt to mirror components of specific indices. ETFs are listed on exchanges while mutual funds, which are managed by professional money managers, are not.

Cryptocurrencies

Since their introduction into the financial market in 2009, cryptocurrencies, or digital assets, have changed the landscape of how financial trading and how we view money. Trading cryptocurrencies, such as Bitcoin, Litecoin, Ethereum and many more, involves speculating on price movements via a CFD (contracts for difference) trading account. The other options are selling and buying the underlying crypto coins via an exchange.

CFDs trading are essentially derivatives, and this allows the trader to speculate on the price movement of a cryptocurrency without taking ownership of the underlying coins. So, for example, you will go short or sell if you think the price will fall and you will long or buy if you think a cryptocurrency will rise in value. A CFD is a leveraged product and this means that you will only be required to invest a small amount, known as margin, to gain full exposure to the underlying market. As a result of this, any profits or loss are then calculated based on the full size of your position. Leverage, therefore, can magnify both profits and losses.

Options

Many traders prefer options because they allow investors to make money on a specific position, regardless of market direction. Options are trading instruments which are derivatives based upon the value of underlying securities, such as stocks. ETF options and currency options trading is also quite popular among investors.

An options contract allows a trader the ability to purchase or sell, depending upon the type of option, the underlying asset. In contrast to futures, a holder of an options contract is not required to purchase or sell the contract if he or she opts not to do so. Call options enable a trader to purchase an asset at a predetermined price within a specified timeframe. On the other hand, put options allow traders to sell an underlying asset at a predetermined price within a specified timeframe. Every options contract has a specified expiration date by which a holder is required to exercise his or her option at a predetermined price known as the strike price.

Customization and Diversification

Being aware of all of the various financial instruments available to trade allows investors to better customize their portfolios to fit individual financial goals and risk tolerance. Also, using a variety of trading instruments and assets will not only provide more opportunities for profitable trades but will also provide diversification. Therefore, not all of one’s risk will be in one place, which could help mitigate potential losses.

All opinions expressed on USDR are those of the author and not necessarily those of US Daily Review.