Trading involves buying and selling of assets or financial instruments. The buyer has to pay some form of compensation to the seller. Traders open a position in the financial market and wait for someone to fill it. Once the order is filled, the position is closed.
There are multiple types of financial instruments traded in financial markets. Currency pairs, stocks, derivatives, margin products, currency pairs and cryptocurrencies are examples of financial instruments. For a noob trader, terms like futures, margin trading and options are confusing. But don’t worry. We will explain all of these in simple language.
A financial instrument is a form of asset or a product that confirms ownership of an asset. All financial instruments are tradable like Cash, Gold, Silver, Business or Resource etc. Some of them are complex due to the underlying asset that they represent. But the point to remember is that no matter what they are or what they represent, you can always trade them.
The two common types of financial instruments are:
- Cash Instruments
- Derivative Instruments
The value of a cash instrument is clear. The derivative instrument, on the other hand, derives its value from another asset.
Cryptocurrencies or digital coins can fall under both the cash instrument and the derivative instrument. The nature of crypto makes it unique in the financial ecosystem. Hence, economist need to realize its potential before we classifying it in any established category.
Traders have to deal with multiple types of markets. For your understanding we will explain a few of them here:
As the name suggests, the spot market involves immediate trading of products, assets, currencies and security in real-time. The price of a financial instrument in the spot market is also known as ‘spot price‘. The delivery is instantaneous and ‘on the spot‘.
In the spot market, buyer and seller decide to trade on right now basis. The transfer may take time. However, both parties agree on the current price. Many crypto and forex exchanges offer spot market trading.
Traders can also do OTC (Over the Counter) transaction in the spot market. It means buying/selling financial instruments to other traders directly. Most centralized exchanges do not offer this feature.
Cryptocurrency exchanges like Binance offer multiple currency pairs against which you can do spot trading. For instance, NEO/BTC Spot market will allow you to trade NEO for BTC. Just open a position and once the order is filled, you will receive the asset in your wallet immediately.
As mentioned earlier, derivatives are financial assets with their value based on some underlying asset. Markets indexes, stocks, bonds, and commodities are commonly known as derivatives.
In the essence, a derivative is a contract between two or more parties. The financial instrument is used as a point of reference. Thus, the contract has value based on this instrument.
There are different types of derivative contracts. We will list the down here.
A futures contract is a derivative product. Traders speculate or guess the price of an asset. They then proceed to settle the transaction on a later date. The last day of trading activity is the expiration date of the contract. On this day, the transaction occurs as decided beforehand.
The settlement of the futures contract is either cash-delivered or physically-delivered. In cash delivery, the value is transferred in the form of cash or cryptocurrency. The physically delivery is in the form of asset exchange like transfer of Gold bars.
Options contract’s nature is only a little bit different from the futures contract. It also gives traders the right to speculate on the price of an asset. However, in options contract traders have the option to settle or not settle the contract. There is no obligation on the parties.
The buyer of options contract speculates that price movement. A call-option signifies traders’ belief that price will go up. A put option, on the other hand, bets on the price going down.
With options contract, you can manage risks in volatile markets such as crypto market. It allows you to hedge your holdings. Crypto miners efficiently protect their assets with options contracts.
Forex or foreign exchange is the currency exchange market. Traders can exchange the currency of one country for the currency of another country on the forex market. It is the most liquid market.
Forex market is the building block of the modern economy. It determines the value of currencies and exchange rates.
The forex traders make use of day trading strategies like scalping to squeeze profits. Inflation, demand/supply and other geopolitical factors have an impact on the value of currencies.
The understanding of financial instruments and financial markets gives you an edge over other traders. You will have a better idea what to do the faced with a conundrum.
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