Find out more about trading, what it involves, how it works, and the risks associated with this short article, Trading 101. Trading is different from investing, so if you're just getting started make sure to do your research if Trading is right for you.
What is trading?
First things first. Trading is very different from investing. Trading is the process of buying financial assets, usually derivatives of much of the same assets as investing, such as stocks, to make a short-term financial return (instead of a longer-term one when it comes to investing). Traders could be buying and selling assets monthly, weekly, or even daily, often with the use of leverage - making it generally, much higher risk than investing, and usually for those more experienced in financial markets.
Why do people trade?
Generally, for much of the same reasons people invest - to try to generate a return. Traders look to achieve this goal in a much shorter timeframe and use leverage to open their positions. Leverage essentially involves borrowing money from a broker, to open much larger positions. While this could mean higher profits, it also means amplified losses if the market moves against you.
What do people trade?
Some of the main markets available to trade are:
Foreign currencies - sometimes known as FX - traders speculate on currency pairs like EUR/USD, USD/JPY, GBP/USD and more.
Indices - major global indices like the FTSE100, or S&P 500 are just some of the main indices people can trade.
Commodities - including coffee, sugar, wheat, cocoa and more.
Stocks - trade on the price movements of world stocks (not in the same way as investing).
Metals - including gold, silver, palladium, and more.
Energy - including oil, gas, and other major energies.
How do people trade?
There is a wide variety of trading instruments used by traders to speculate on different types of assets and contracts. Some of the most popular include:
Contract for difference (CFDs) - refers to an agreement between two parties to trade financial instruments based on the difference between the entry and closing prices.
Options - give the buyer the option to buy or sell an asset at an agreed-upon date and price. 'Call options' provide the option to buy, whereas 'put options' provide the option to sell.
Futures - standardised contracts that serve as an obligatory agreement to buy a particular asset at a fixed price in the future.
Forwards - contracts similar to futures contracts, but are customisable as opposed to standardised.
Before you consider trading
You should only ever trade once you understand all the risks, and only use money you can afford to lose. All investors should practise paper or demo trading before considering risking real money. This enables users to learn risk-free and experience the intricacies, market volatility, and processes involved in trading before using real money. Most trading providers offer demo accounts free of charge, so be sure to take full advantage of this and practise for some time before considering trading.
What are some of the risks?
Capital risk: As with all financial investments, trading involves risk. Trades can go down as well as up and you could end up with less than you started with. Trading often comes with an enhanced risk, through the use of leverage which can magnify losses as well as profits. You may even lose more than your initial position.
Fees and commissions: Costs can vary between trading providers so be sure to understand exactly what they are. Trading may also include other commissions, spreads, and expenses that may lower your returns.
Liquidity: This essentially means, how readily and easily an asset is bought and sold. Not all trading instruments and asset classes share the same level of liquidity, so it can take longer than expected in some cases to buy and sell your holdings.
The risks summarised here are just a few of the risks faced when trading. There are many more, so make sure to do your research.
Is trading right for me?
It may not be. Deciding whether or not trading is right for you depends on factors such as your financial goals, experience level, and risk tolerance. Be sure to be fully aware of the complexities of trading before risking any real money. Consider making use of free practise paper trading available with some providers before making any financial decisions.
Want to learn more?
Interested in investing but don’t know exactly where to start? Try the free Pluto app. Learn investing basics, and practise in a risk free environment with no real money. Find us on the Apple App Store.