Instruments traded in the Financial Markets
In this lesson, we will take a look at instruments traded in financial markets and institutions. These are namely stocks, currency pairs, stock indices, commodities, and cryptocurrencies. What are their specifications and what should you know about them? Let’s find out!
A stock is a security that the owner becomes a shareholder of the company. A shareholder has different rights. E.g. he/she is entitled to participate in the profit of the company in the form of dividends but also to participate in the management of the company, inter alia, by being entitled to vote at the general meeting or to participate in the liquidation balance of the company in the event of a liquidation.
Why are stocks traded?
Firstly, there is an incentive for companies to raise capital by selling shares on the stock exchange. Investor motivation is to evaluate their resources. The company’s liabilities are guaranteed by shareholders only by their stake, which is the share price multiplied by the quantity purchased.
Types of stocks
We distinguish stocks in terms of form on:
- Paper shares – physical documents
- Dematerialized shares – shares entered into electronic records
Then the shares in the name of the natural or legal person, or shares of the owner/bearer, are anonymous and no longer used today.
How to trade stocks
Stocks can be traded on stock exchanges but also through CFDs.The stocks are traded entirely online. Examples of significant shares: Microsoft, Apple, etc. For certain shares, we use the term blue chip. These are the shares of the largest and most profitable companies, being traded on the stock market exchange, having stable growth, and paying dividends on a regular basis.
Currency pairs are traded on the foreign exchange (also known as Forex), which is the biggest market with a “$7.5 trillion” daily volume (In 2022. Source: bis.org). A currency pair consists of two currencies, where one currency is called the base currency and the other is the quote currency.
We trade currencies in such a way that we speculate on the strengthening of one currency against the other currency. We can explain the relationship of currencies to the EURUSD currency pair, which is the most popular and most frequently traded pair. In this case, the base currency is the euro and the quote currency is the US dollar.
What does the EURUSD rate at the 1.12 level mean?
This indicates that 1.12 USD is required to buy 1 euro. The rate is always the unit of the base currency.
Currency pairs are divided into 3 categories – majors, minors (or crosses), and exotics.
Other examples of currency pairs: USDJPY, AUDUSD, EURCHF.
Currency pairs are characterized by high liquidity and often volatility too, depending on the fundamentals. Price usually moves up to 1-2% daily.
The stock index is the sum of many different instruments traded on one exchange. The stock index is an indicator of the development of a given segment or economy of the country as a whole. Most often, we have stock indices that reflect the value of shares traded on a given stock exchange. For example, the most famous stock index of the Frankfurt Stock Exchange – DAX, is composed of a share price by 40 most important selected German companies. (BMW, Adidas, BASF, Bayer, Lufthansa, Siemens).
Examples of stock indices: Dow Jones Industrial Average, S&P 500, FTSE 100.
The value of stock indices varies based on the movement of all shares that are contained in the index.
In general, indices are a stable investment instrument. As a rule, they are not volatile just as any individual stock titles can be. Therefore, investment in indices is gaining increasing popularity among investors.
We can describe commodities as goods traded in markets without quality differences. Deliveries from different suppliers are mutually substitutable. For example, a commodity cannot be a car that is produced by many different means and at different prices. The most well-known traded commodities are crude oil, gold, and natural gas, but also coffee, corn, orange juice etc.
There are two types of traders on the market – the first (also being a minority) only speculates on price development, while others are really buying that particular commodity.
For example, Starbucks secures its coffee supply a year in advance through the exchange.
For commodities, we need to take greater risks – their price depends on climate change, global resource outages, trade wars, etc. It is important to understand that some commodities are correlated to the certain currency of a particular economy. Correlation of price developments between currency pairs and commodities:
- Crude oil – Canada
- Gold, iron ore – Australia
- Dairy products – New Zealand
- Natural gas – Qatar
There is also a need to monitor world affairs, macroeconomic data, population growth demands, etc.
Cryptocurrencies are a type of digital currency or, in other words, electronic money. The biggest problem or for someone else, the advantage is that electronic money is not regulated. The most famous is Bitcoin; others are Dash, EOS, Ethereum, Ripple, Litecoin, etc. The price changes of cryptos are very steep – e.g. Bitcoin in 2021 ranged from $29,000 to $64,000.