What is financial trading – Part 1

What is financial trading – Part 1

What is financial trading? Part 1
Photo by @andreyyalansky19

Financial trading is the buying and selling of financial products. The aim, of course, is to make a profit. 

Here we look at the history of financial trading, the influence of the internet, and how you can get started. We also explain how you execute trades and tell you a little about strategy and risk.

The history of financial trading 

The history of financial trading is long and interesting. Although it can be traced back to biblical times, modern financial trading started around the seventeenth century with deals done in coffee houses and business premises especially in London and Amsterdam. 

In those days, because of the need to account for long sea voyages, merchants and ship owners built a kind financial futures market. They’d agree to a price for goods once they had been safely delivered. You might call it ‘a forward price’. Transport insurance was also arranged and in those days, it was critical.

Amsterdam hosted the first financial trading exchange to trade shares in companies and the famous Dutch East India Company was the first company to be listed there in 1611. 

The first U.S. stock market

The first US-based stock exchange was in Philadelphia. It opened in 1790, just two years before the New York Stock Exchange and it focused only on buying and selling shares in US companies.

Why was ticker-tape important

When the telegraph was invented ticker-tape was used to transmit stock price information through telegraph lines. Amazingly, this method of communication continued for 100 years (1870-1970) with the obvious advantage that it allowed financial trading to take place simultaneously across several locations. 

Thin paper strips were fed through machines called stock-tickers abbreviating company names into alphabetic symbols, and containing key stock price and volume data. 

The concept of the old ticker still exists today and is often seen in the scrolling electronic tickers on the walls of financial institutions and in the financial media. 

The Dow Jones Industrial Average (DJIA)

The Dow Jones Transportation Index was set up in 1884 by Charles Dow, an American journalist. It is the oldest index of publicly quoted companies and its creation coincided with and facilitated the huge boom in railway building seen in the USA during this period. Dow also founded the famous and widely respected The Wall Street Journal.  

By 1896, Dow had composed an index of the 12 largest U.S. companies by adding up their share values and averaging them. Before long this had increased to include the 30 largest U.S. publicly traded companies referred to as the DJIA. Dow came up with a set of principles for analysing and understanding market behaviour (Dow Theory) all of which served as a foundation for modern day trading analysis. 

The trading pit

Over the years financial trading changed its character. ‘Outcry pits’ became places where traders would take orders verbally (and loudly!) for the contracts they had to sell. These raucous venues were where the traders, working for brokers, would buy and sell from other brokers in the hope of making a great profit. 

 

Trading pit
Photo by Alamy stock photo

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The internet changed trading

Today the internet has transformed most financial trading which now typically takes place online electronically. 

Estimates of the proportion of electronic trading today vary from 84% of investors in US markets (Greenwich Associates in their “Technology Transforming a Vast Corporate Bond Market – Q4 2017 report) to well over 90%. Trading floors in outcry pits are now much quieter! 

A big change is the fact that we can now trade 24/7 and we can trade anywhere in the world – providing we have internet access. Importantly, the internet means that online trading is now something everyone can do. You don’t have to be a financial industry professional.

About $5trillion is traded every single day on the Foreign Exchange (FX) market, a testament to the power of electronic trading. 

It is not completely over for physical exchanges. The NYSE and NASDAQ are still open and in Chicago, outcry pits still exist. Livestock, agriculture and other commodities can all be traded there.  

What is trading? 

Trading began as barter – the transfer of goods or services from one person to another. Today this transfer usually takes place in exchange for money but in places where the economy may have collapsed, say because of war, people often resort to barter.

Unlike investment, financial trading is all about pursuing a profit in the relatively short term. The ‘market’ is the system or electronic network in which people can trade. Individual financial trading is called ‘Retail’ and usually takes place through brokers on platforms such as the MetaTrader, MT4 platform. 

Retail traders

A huge array of financial products are available for retail traders to trade through their broker such as forex, indices, shares, commodities and cryptocurrencies. Caluso Markets enables you to trade hundreds of financial products.  

Institutional traders

Institutional traders are companies, institutions, central banks and governments who usually have more to invest than retail traders.

But their motivation is the same – to make profits. For some of these institutions, trading is part of their business model. For instance if they regularly buy capital overseas they may also need to buy the currency to enable them to make that overseas purchase. And they will be looking carefully at Forex prices to make the best trade.

What instruments to trade and how

Firstly, there is a lot of financial jargon. Don’t worry about it. At the beginning, all you need to do is keep it simple.

Financial products can be traded through what we call ‘cash instruments’ like Forex, stocks, bonds, or through ‘derivatives’ like futures contracts and CFDs (contracts for difference). Most people buy and sell these products on an electronic trading platform through a broker.  

Typically, financial trading takes place either through an exchange such as the New York Stock Exchange (NYSE) or “over the counter” (OTC). 

OTC trading

When you decide to buy a financial product “over the counter” through a broker, you’re making a deal with another person or entity through your broker. You might, for instance, decide to buy a CFD (contract for difference) through CALUSO.  

Exchange trading

When you buy or sell via an exchange you’re engaging directly with ‘the counterparty’ that is the person you’re buying from or selling to. By going through the exchange (still via a broker) you are able to gain direct market access and can trade directly with the seller (or buyer). 

 

Trading Exchange
Photo by @doondevil

 

How does trading work? 

Let’s begin at the beginning.

Setting up

You need to open a trading account with a trustworthy broker. You need to put some funds into the account (with which to buy your selected financial products) and select the financial markets in which you want to trade.

Making the Trades

Once you have your trading account up and running you can begin buying and selling financial products through your broker. Your order will be routed to the electronic market by your broker on your behalf. Orders to buy and sell can be opened or closed manually or, once you’re more experienced, you can employ an algorithm to do it for you. (More about this later). You take your profit or your loss when you close your trade.  

Strategy

Many traders like to stick to one set of trading instruments (like EUR/USD) or asset classes (like Forex). Others trade everything, in effect diversifying their risk. There are different sorts of analyses you can use to try to guide your trading eg. detailed fundamental analysis or technical analysis. And of course, you can use the financial media to help you make decisions.  

Risk

Whatever you decide to trade and in whatever quantities, it is critical to manage your financial risk or your ‘exposure’. Never risk more than you can afford to lose. 

 

Risk
Photo by @carlo_vstek

 

Types of financial trading firms

Remember, the vast majority of the volume traded is carried out by financial firms and institutions. 

These are normally split into two categories; retail and institutional.

Retail – These are the firms that enable individuals to trade. Many brokers are considered retail because their clients are individuals who don’t get paid to do it for a living. Retail represents a small portion of the volume in the financial markets.

Institutional – Institutional traders account for the vast majority of the volume traded. They include banks, governments, and several types of funds (hedge funds, mutual funds, pension funds, etc). 

We’ll talk about this in more detail later.

More About Financial Trading 

Our lessons and modules cover specific aspects of trading in detail. In this lesson we’ve covered the history of trading and said a little about what constitutes financial trading and who does it. In the next part of this lesson we’ll look in more detail at the trading process.

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