Trading 101 🖥️
Find out more about trading, what it involves, how it works, and the risks associated in this article. Be aware trading is different from investing and comes with a high risk of losing money rapidly due to leverage. You should consider whether you understand how trading works and whether you can afford to take the risk of losing your money.
What is trading?
Trading is the process of buying 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 like with investing). Traders could be buying and selling investments weekly, or even daily, often with the use of leverage - making it higher risk than investing, and usually for those more experienced in financial markets.
Trading vs investing
Both 'investing' and 'trading' describe the process of buying and selling financial assets, with the ultimate goal of generating a return. However, these words tend to refer to different financial instruments, which come with their own risks, differences, and complexities to be aware of. Understanding the difference between the two can help an investor determine which - if either - might be the most appropriate for them. If you are not sure, it is possible trading may not be suitable for you. If you do decide to trade, it is a good idea to use demo or paper trading accounts, offered by most brokers to practise for some time before considering risking real money.
Why do people trade?
Generally, for much of the same reasons people invest - to generate a return. Traders look to achieve this goal in a much shorter time frame and speculate in a high-risk, potentially high-reward way by leveraging their positions. While this could mean higher profits, it also means amplified losses if the market moves against you.
What is leverage?
In trading, leverage refers to the use of borrowed money, to increase the size of a position beyond what would be possible with your own money alone. It allows traders to control a larger position size with a relatively smaller amount of their own money. While leverage can amplify potential profits, it also heightens the risk of significant losses, as both gains and losses are calculated based on the total leveraged position. Effective risk management is crucial when using leverage to mitigate potential downsides and protect against market volatility.
Where do people trade?
Most retail traders use trading platforms and apps to access the markets. We have provided a comparison of such brokers and platforms here, so you can easily compare different offerings to see if one is right for you. Before choosing a broker, make sure they are regulated and reputable. Also be sure to take advantage of paper trading accounts offered by most brokers, which are usually free. They involve no real money and are a good way to experience the markets without risking real money. When you feel you are ready, be sure to continue practising for a few more weeks or months in a risk-free environment before considering risking any money.
What are the main markets?
Some of the main markets available to trade are:
Global 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:
CFD (contract for difference) - refers to an agreement between two parties to trade financial instruments based on the difference between the entry and closing prices.
Options - options contracts 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 are similar to futures contracts, however they are customisable, as opposed to standardised.
What are some of the risks of trading?
As with all financial investments, trading involves real 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 if the market moves against you quickly
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.
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. This can add increased risk to traders in the event they wish to alter their positions quickly.
Before you trade?
You should only ever trade once you understand all the risks, and only use money you can afford to lose. All traders 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.
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. It’s always a good idea to have ample savings and an emergency fund before considering trading or investing your money.
Interested in investing or learning more about trading but don’t know exactly where to start? We would always recommend practising without any real money before you start. Try the Pluto demo (no real money) environment on the free Pluto app.