What is financial trading – Part 2December 29, 2020 2021-01-25 20:28
What is financial trading – Part 2
Financial trading is all about exchanging a product for some money. In some ways it is incredibly easy although many try to make it sound complicated! In this lesson we look at how to choose your broker, which markets to trade in some different styles of trading.
How to Start Financial Trading
The number one step is choosing a broker.
1. Choose a broker
A google search will provide lots of information – usually from brokers who have paid for their names to be top of the search engine list! But you don’t just want a broker that paid to be on google’s first page. Think about these factors:
- Is your broker regulated? Protecting consumers is the job of the regulators and a broker that is regulated will have to follow strict rules to ensure that you and your funds are protected.
- What kind of Reputation does the broker have? Do some homework on this. Look at reviews and feedback and check what the Regulator says about them.
- Has the broker won any Awards? This might suggest that the broker has good systems and procedures in place. But remember, an award won 2 or 3 years ago is no guarantee of excellence now.
- Does the broker provide good quality News & analysis? The best brokers have analytical, sales and service teams all dedicated to helping you to trade well. And make sure you understand which products they trade and on which platform.
- Will the broker help you to learn? As a beginner, you will want lots of help and guidance. A broker that offers financial trading education in the form of webinars and on-line courses is one that wants you to become successful.
At the outset, you will probably want to open a demo account with a broker you like, unless you have previous experience. This gives you a chance to check out the efficiency of their trading platform. Use of a third-party platform such as the highly respected MetaTrader MT4 is often a good idea.
This period of demo trading will enable you to evaluate the performance of both the broker and the platform and get to grips with the charging mechanisms and levels.
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2. How much do you deposit?
This is critical and a little bit scary! The initial amount you have available to deposit in your trading account will determine the type of account you can open. A professional trader, for instance , will be able to trade using more leverage (risk).
First, only deposit funds you can afford to lose and especially at the start, only risk a small percentage of your capital on each trade. Make sure you limit your market exposure and use these early trades to try to understand your own attitude to and tolerance of risk.
3. Which markets do you want to trade in?
There are lots of financial trading markets, including stocks and shares, equity indices, forex, cryptocurrencies and commodities. You can pick one to start with or dive into several. But remember that the size of your account may determine which market you can become involved in. Trading major forex pairs for instance, may give you greater leverage compared with other securities because the spreads are often very competitive due to the high liquidity of this market.
It may be that you have a particular interest in one market or, after trading for a few months, you’ll feel ready and able to enter more than one.
4. Style of trading
Here’s some jargon for you. Sorry! Four trading styles you’ll hear about are scalping, day trading, swing trading and position trading. The last two are very similar and so are often combined. We won’t go into them all now but eventually, you’ll need to work out which style works for you.
One of the most popular choices, particularly for part-time traders is swing trading forex or equity indices. Typically this suits people wanting to supplement their income while they do their main job.
With swing trading you’re aiming to take advantage of market swings, closing your trade when the swing feels like it is ending and perhaps trading in the other direction when all the signs are right.
It’s easy to check on your positions periodically during the day and you don’t need to be constantly glued to the screen. You have time for your other job! It’s also easy to set alarms to warn you of any critical events that may affect your trading positions.
How does trading work?
You’ve done your homework, you’ve decided on your broker, your market, your account is set up and you’re ready to trade. Now what? Is it just a matter of pressing a button?
What kind of trading do you want to do?
Most retail traders trade in shares, forex, equity indices, commodities and cryptocurrencies. And there are many ways of doing it.
In forex trading, for instance, you can use your cash account to buy and sell directly in the spot market or you can trade a CFD (contract for difference) of an equity index such as the DJIA; often referred to as the US30 index.
You may want to take a longer-term view of a particular currency and become a position trader, holding your preferred currency for months and assuming it will remain strong. Position trading like this is closest to long term investing and you will need to understand the charges associated with it.
The lesson on financial markets will help you to understand each market but to get a quick idea of the two most popular, check out these below.
By market volume, this is the main type of financial trading with a daily turnover estimated at $5.2 trillion.
An accessible market
Forex trading has surged thanks to the internet especially for retail traders with relatively small sums of money.
Brokers make it possible for you to buy and sell currency pairs with as little as $100 in a micro account and risking as little as $1 per trade.
What are you trading, when forex trading?
When we talk about forex trading we’re talking about trading currency pairs. You have a base currency, (on the left) and a quote currency on the right. Typically the base is equal to one and the quote is how much of the quote currency you can get for one of the base.
Take GBP/USD. GBP is the base and equal to one while the quote is the USD. If the price is 1.23, then you can buy 1.23 US Dollars with £1. If you decide to buy this forex pair, you expect the GBP to become more valuable, that is you expect the price of £1 to go up to say 1.24.
Forex trading categories
There are several different Forex trading categories – majors, minors, or exotics, determined by the state of the economy of the two currencies and the volume traded.
Major forex pairs all include the US Dollar. There are four major pairs EUR/USD, GBP/USD, USD/JPY, USD/CHF
This category also includes three commodity pairs – USD/CAD, AUD/USD/ NZD/USD
Forex minor pairs are any variation of the currencies above that don’t include the USD. e.g. EUR/JPY, GBP/JPY, AUD/NZD, GBP/AUD
Great name! Forex exotic pairs include a currency that isn’t mentioned in the above lists. For example, if the South African Rand (ZAR) is paired with the USD, this would be considered an exotic pair (USD/ZAR).
Since the Thatcher government’s privatisation programme of the 1980s which encouraged individuals to buy stocks in previously publicly owned companies, stock trading has become extremely popular. Huge volumes of well-known brands are traded on the stock market.
Long term stock trading
Millions of private investors hold stocks and shares as part of their financial portfolio, balancing the low returns of say, a standard savings account with the risks associated with stocks. Similarly many institutions like Pensions Funds and banks buy stocks balancing those they deem as ‘safe’ with those that might be a riskier bet.
Short term stock trading
As an individual retail trader, stock trading tends to be betting on short term price changes. These traders are often very active in the market, perhaps making decisions several times a day, perhaps just a few times a month. Some buy and hold stocks for years.
Right at the moment many of the most popular stocks are tech stocks such as the FAANG stocks; Facebook, Apple, Amazon, Netflix and some of the newer biotech companies. Trading in these stocks requires you doing some homework perhaps by researching the various technical and fundamental analyses available.
How do you trade stocks?
Trading CFDs (contracts for difference) is popular because it doesn’t take much money. Let’s look at an example.
Suppose you wanted to buy 100 shares in Amazon, at $3,000 per share. $300,000 is a lot to spend for most of us. But trading these shares using a CFD means that you trade on the price movement and not on the actual stocks. So, although buying 100 CFDs in Amazon shares represents a trade of the same size, you only need to pay a portion of that.
How much of this type of trading costs you depends on the leverage offered by your broker. But generally speaking, trading the difference is more cost-effective than buying the actual shares in full. That said, you should remember that although trading CFDs reduces your initial outlay, it does magnify your profits and your losses. It is critical therefore that you properly understand how leverage works.
Financial Trading Summarised
So, in “what is financial trading?” We’ve looked at the trading basics, its history, how it works, and its various components from brokers and markets to trading styles.
Before moving on, now would be a good time to do some research about the type of trader you want to be. We really want you to succeed and when you feel ready, we invite you to work out in the next lesson in our Trading gym!