What markets can I trade – Part 1

What markets can I trade – Part 1

Markets to trade
Photo by @ako

As a trader you can buy and sell in several financial markets online but most online market trading takes place in; shares (stocks), indices, forex, commodities and cryptocurrencies. You can trade a variety of trading instruments through your broker and via trading platforms like MT4.  

What markets can I trade online? 

There isn’t a best market to trade. Many beginners start with forex while others swear by commodities. Whichever market you choose, trading online is relatively straightforward. It’s a simple matter of choosing a broker and opening an online trading account. Once you’ve done that, decide which markets you’d like to trade but make sure you fully understand your chosen markets. 

Stock Market Trading 

If you opt to trade a company’s stocks  or shares you probably won’t behave like an investor – ie holding stock for the medium or long term. Instead, as a trader you are looking to predict the direction in which your chosen shares are likely to move and then buy and sell in the short-term in line with your trading strategy. 

Remember you can trade stocks by actually owning the share or the stock or by trading them as derivatives like a CFD (contract for difference).

Trading stock CFDs

As we’ve explained, when you trade a stock CFD, you don’t actually own the stock.  Instead, you make an agreement with your broker to pay the difference between the buy and the sell price, (or the sell and the buy price), depending on the direction of the shares.

Because you don’t own the actual stock, this means you can go short, increasing your trading opportunities. (Note: Going short is a trading technique in which an investor sells a security with plans to buy it later. Shorting is a strategy used when an investor anticipates that the price of a security will fall in the short term).

CFD trading can be cheaper than buying and selling shares because you don’t have to invest in the full cost of owning the shares; you only trade the difference. But, a word of warning, while CFDs can enhance your profits, it can also increase your losses, so it’s vital you understand how it works.

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What are the best stocks to trade?

There are popular stocks to trade but no best stock. If we knew that we would all be rich!

Tech shares can be attractive as they’re popular and carry familiar brands. These stocks are traded in enormous volumes on the NASDAQ tech index and as a result their liquidity is high. This can be helpful as the large volumes keeps the transactional cost of buying and selling these shares low so that you’re more likely to buy at the price you intended to.  

Popular tech stocks are sometimes grouped together under the acronym FAATMAN: Facebook, Apple, Amazon, Microsoft, Alphabet (formerly Google), Tesla and Netflix. You might also have heard of FAANG which is an acronym of just the five most popular and best-performing American technology companies: Facebook, Amazon, Apple, Netflix and Alphabet. These are all popular stocks because most people have heard of the companies and know what they do.

When you trade stocks on your platform you will see the price to buy, the price to sell and the spread, which is the main cost of the transaction.

 

Photo by @eddieespinal

Trading stock market indices

All FAATMAN stocks are all traded on the NASDAQ index. It’s sometimes difficult to know which tech stocks to buy. If you’re not sure you could instead ‘buy the NASDAQ’, which is essentially buying a basket of all  their stocks. Trading stock indices in this way reduces your exposure to the volatility of a single stock.

The DOW 30, (sometimes called the U.S. 30) is also a popular index on trading platforms and refers to the top 30 companies in the U.S. Here in the  U.K.  the FTSE 100 is also a popular equity index and holds the top 100 companies in the U.K. 

If you elect to trade indices like these, then you are taking a more global view of the performance of a sector. You might, for instance, think that the tech industry and the various sectors within the industry are bullish which might encourage you to consider buying (going long) the NASDAQ. We’ll cover this in more detail later on in the course when we talk about index market trading.

Shares vs stocks – What is the difference?

We’ve used the terms stocks and shares interchangeably up to now but there are technical differences. Stock refers to common stock in a company. Shares are the smallest single denomination of a company’s stock. But in practical terms there is no tangible difference between trading stock and trading shares. They both refer to the same financial products and you trade them both using the same process. 

Terminology differs slightly in different countries. US traders tend to refer to the stock market and trading stock. U.K traders prefer to use the phrase ‘share trading’ and talk about ‘equity indices’ or ‘share indices’ instead of the more American term ‘stock indices’.  

How does stock trading work?

Stock trading work on an exchange floor. Let’s take an easy example:

  1. You instruct your broker to buy 100 shares of Microsoft.
  2. The order department sends it to the floor clerk on the stock exchange. 
  3. The floor clerk alerts the firm’s floor traders.
  4. The floor traders find a counterparty willing to sell 100 shares of Microsoft. 
  5. The two parties agree on a price and complete the transaction. 
  6. The order process goes back up the line, and your broker will let you know the final price for your shares.  

The process can take a few minutes or longer, depending on the stock and the market. A few days later, you will receive the confirmation notice by email or in the post. 

Electronic stock trading

This is the most usual form of trading today especially for retail traders. Even physical exchanges like NYSE handle a percentage of their volume electronically and some like the NASDAQ are entirely electronic. 

Electronic stock trading has the advantage of greater speed and efficiency than the physical exchange process which is why many large institutional  traders prefer electronic methods of trading. Because individuals do not have direct access to the electronic markets you still need a broker. It is your broker who  gives you access through your trading platform to an electronic exchange and computer networks which then match buyers and sellers. 

As an individual trader you are extremely close to the market because your online broker’s objective should be to match your order within milliseconds and without any interference. This means that individual traders like you who trade electronically on platforms like MT4 get almost instant confirmation of your trades. 

 

Electronic trading
Photo by @mraoraor

What is forex market trading? 

Forex market trading is all about the art of trading currency pairs in the largest marketplace on planet earth. And by large we mean an estimated turnover of over $5 trillion every day the forex markets are open. 

If you’ve ever been abroad then you will already have participated in the currency market. You may have been on holiday to Germany and exchanged your Great British pounds for Euros. You may have done it through a bank or a Post office and they will have given you a price to buy. This won’t have been the exact market price but the small difference you might have noticed is simply their fee for conducting the transaction. 

Pros and cons of forex trading

Pros

Accessibility – It’s readily accessible, it’s easy to sign up with a broker and you get the chance to trade lots of the world’s currency pairs.

Liquidity – It has more participants than any other market which means that even exceptionally large orders are likely to be fulfilled at the required price, with little deviation.

Fees – Most brokers don’t charge a commission to trade the forex market. Instead fees are taken through the spread and due to the liquidity of the market this can be relatively small.

Various trading styles – All sorts of trading strategies (Technical, fundamental and sentiment strategies) can all work in this market.

Leverage – You don’t need to front the entire cost of your trade, so you have less capital at stake which in turn can enhance your profits. But note: leverage can also be a con.

Cons

Volatility – It’s a volatile market that can be affected by a surprising number of external factors. So your trade can tumble from positive to negative in seconds.

Unregulated – As it’s over-the-counter there is no central exchange or regulator. As the consumer, all the risk is yours and no-one is looking out for you.

Leverage – While leverage can enhance your profits, it can do the exact same for your losses. It’s essential you understand this principle before you trade using leverage.

How does forex trading work?

Corporate

Most forex market trading (perhaps as much as 80% of market turnover) is carried by large institutions such as banks who are looking to fix currency prices for their corporate clients. They do it to ensure the smooth running of international commerce.  

Let’s take the example of a US-based car retailer looking to import 50,000 cars from Japan. Ideally the retailer would like to fix the future price of his dollars versus the yen. If he doesn’t do this (that is hedging against currency fluctuations)  he could lose as much as  $500 per car if the dollar/yen price ratio changes unexpectedly between order and delivery – expensive when you’re importing 50,000 of them! 

In hedging, firms are trying to insure against any future currency fluctuations which could impact the profit on the order. In this case, a wiser car importer might instruct their institutional broker to trade X amount of USD/JPY to protect themselves.

 

Photo by @tampatra

Retail

Retail forex market trading accounts for only about 10% of FX market turnover. Retail traders typically use CFDs, spot trading or spread betting to trade forex. 

Unlike the institutional banks who hedge for their clients, retail clients tend to be speculators. They bet on currency movements by trading three groups of currency pairs; major, minor and exotic. 

Major currency pairs always include USD, such as USD/JPY, GBP/USD and EUR/USD. Minors don’t include USD as the base or counter currency, such as EUR/GBP and EUR/JPY. Exotic pairs might include the Swiss krona or Polish zloty or Hong Kong dollar.  

Forex vs stocks 

There are several critical differences between trading forex versus stocks.  

  • Cost of doing business – You may need more money and available margin in your account to trade shares because you won’t be able to access the higher leverage which FX trading offers.  
  • Spreads – Compared with forex pairs, your broker is likely to quote larger spreads with shares.  
  • Volatility – The price of the stock can also move by significant percentages during trading sessions, with swings of more than 5% in a day not uncommon. By contrast  a swing of over 1% per day is extremely rare with a forex pair. 
  • Risk management – As a result of the above, your risk management techniques, including deciding where to place ‘stops’, will be put under greater pressure when trading stocks.  
  • Different fundamentals – Stock markets react to different economic data than forex. For instance Apple’s stock may fall in price if they issue disappointing financial statements, A currency might rise or fall depending on a central bank intervention or a political statement. 

Forex                                                                                                   Stock

Key differences

Exchange currency pairs

Exchange company shares

Suitable for long and short term traders

Better for longer term investors

Lower spreads

Higher spreads

Greater leverage/less margin needed

Less leverage/more margin needed

Smaller price movements

Larger daily price movements

Trade 24/5

Open and closes every day

Highly liquid

Larger chance of price gaps

Index market trading 

Trading an index means buying or selling a basket of shares. If you trade the DOW 30 , you’ll trade the top 30 companies quoted in the USA on the DJIA (Dow Jones Industrial Average). If you trade the U.K. FTSE 100, then you’re trading a basket of top 100 quoted firms on the U.K. stock market. 

Trading indices is popular because you’re spreading your bets by looking at the direction of whole sectors and the overall market rather than speculating on individual shares. It’s usually considered less risky because you don’t have as much exposure to potentially volatile individual stocks.

How does index trading work? 

You can trade many indexes but in general they are the top 30, 100, 200 or 500 of a country’s major quoted firms, such as the S&P 500 (USA), ASX 200 (Australia), DJIA 30 (USA), FTSE100 (U.K.), CAC 40 (France) and the DAX 30 (Germany).

When you trade an index you’re betting on whether an index will rise or fall. Index trading works in a similar way to other markets. And like other markets, there are several instruments you can use.

  • Derivatives
    • CFDs – You can trade a CFD of the index. This is an agreement between you and your broker where the difference between your opening and closing price will be paid either by you (if you lose) or by your broker (if you win).
    • Futures and options – These contracts give the trader the right to buy or sell at a predetermined price or time.
  • Cash indices – This means you are trading the price of the underlying market. This normally comes at a cost if you hold it overnight.
  • ETFs (Exchange Traded Funds) – This means investing in funds that have exposure to the index. It might be a fund that simply follows the index or a mutual fund that invests in several products of which one is an index.

Index trading strategy

The simplest example of an index trading strategy would be to buy the NASDAQ index. You might do this because you believe the tech share market in the USA is healthy and likely to remain so for a while.  

Perhaps you bought this index (gone long) at the start of the Covid pandemic because you believed people would do more work from home, need more tech and do more online shopping. Fundamental analysis including reports from analysts might have supported your decision. 

You won’t buy individual shares such as Facebook, Netflix and Amazon, instead you buy (go long) the complete NASDAQ index. 

To do this you use your platform to find the NASDAQ ticker and execute your trade. Obviously you take great care to stick to your trading plan. 

Remember, it’s easier said than done to make a plan and stick to it. Opportunities outside your plan might come up and tempt you. It’s crucial that you think about the risk you’re taking and apply the necessary margin and leverage calculations.  Always think about using stops and limit orders to take advantage of what you see as a viable trade.

 

Index trading
Photo by @stuart.renn

Commodities market trading? 

There are two types of commodities – soft and hard. Agricultural products such as wheat and sugar are categorised as soft-commodities, precious metals such as gold and platinum and industrial metals such as copper are categorised as hard. There are further also classifications  such as  agricultural, energy and metals.  

How and why commodities markets move

The production and consumption of commodities changes due to the weather (current and forecast), supply, demand, economic and political events and the value of the U.S. dollar. This means that commodity prices often fluctuate significantly and daily. 

The Covid-19 pandemic significantly affected the commodity market. When the crisis broke, oil prices collapsed on international markets because international trade and travel almost completely dried up. You, like millions of others, may have been told not to travel. Much less fuel was sold and the reduced demand for oil meant that the price of oil stocks dropped like a stone. 

Where commodities trading takes place

Commodities trading still takes place in venues and exchanges, and even in live trading pits. Fortunately retail traders are still able to trade various commodities electronically on their trading platform.  

How does commodities trading work? – Example 

Like most other financial markets you can trade commodities using several instruments. Typically these instruments are divided into two; those that enable you do take ownership of the underlying asset and those that don’t.

How to buy gold in the commodity market without taking ownership

As most market participants don’t want to transport physical gold or take ultimate ownership of, for example, several tonnes of gold, (well some might!) futures contracts are often traded in this market instead. These are contracts to buy or sell at an agreed-on price on a specific date in the future.

Commodities contracts are priced in U.S. dollars, so commodities’ prices are sensitive towards the fluctuations in the value of the dollar.

If you’re looking to trade a commodity like gold on your platform you’ll get a simple, derivative version of the aforementioned process to deal in. Your broker might base their prices on the future value of the asset and the expiry date or dates and may wrap up the deal as a CFD (contract for difference).

 

Commodity trading - oil
Photo by @JBL

What other markets can I trade online? 

Many individuals choose to trade the relatively new cryptocurrency market. Again, you would do this through your broker (assuming they offer them) and get access to leading coins such as Bitcoin, Litecoin, Ethereum and Ripple. 

The prices of cryptocurrencies can be subject to extreme fluctuations, and in some jurisdictions, the leverage offered is minimal or non-existent. It can therefore be a difficult and risky sector to trade. That said, the very volatility of the crypto market also attracts traders because it means that the upside can be huge. 

Options and futures markets are not accessible via your MT4 platform through a broker but they do present legitimate opportunities which you might want to research as part of an overall trading and investment strategy to balance out any wider portfolio you hold. 

We’ll talk abouts options and futures in more detail next.

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