What is trading?
Every time you pay for an item at a store or sell goods that you own, you are engaging in trading. And if you sell goods that you don't own yet, but will pay for after you've made the sale, with the intention of profiting on the deal – that's also trading. In fact modern financial trading, such as trading on a stock exchange, is just another form of exchanging goods for financial gain.
Trading history >
Trading today >
A History of Trading
Trading as we know it today originated in the development of agricultural markets. At first, the seasonal nature of harvests usually resulted in a glut at harvest time, with low prices for the farmers. However, at other times of the year there would be a shortage, resulting in high prices for the consumer.
By the 1700s, farmers and buyers were agreeing in advance on prices and delivery of produce in order to guarantee better prices for the farmer as well as to stabilise prices for the consumer. In this way the first form of forward trades was started, and became the precursor of futures trading.
As agricultural trading volumes increased, the need arose for an organized exchange and a standardized system of trading units and quality grading. In 1848 the first trading exchange was founded, the Chicago Board of Trade, to regulate the growing wheat trade in North America.
Share trading first appeared when the early international trading companies, such as the Dutch East India Company, sold shares to raise funds for sending their trade ships to the East – investors could receive a share of the eventual profits, proportionate to the size of their initial investment.
Similarly, the first ever government bonds were issued in 1693 by the English government to raise funds for a war against France.
Trading today >
Trading today
Today trading is the term that we use to describe the buying and selling that takes place in the financial markets. Modern trading is all about buying and selling goods that you never actually take possession of. Unlike buying a house or any other physical object, when you trade in the financial markets, you buy and sell financial instruments that are only represented on paper – or on your computer screen via online trading.
The goods that are traded on modern financial markets are financial instruments like equities, bonds, futures, and so on.
Traditional trading
Before the introduction of the Internet, financial trading traditionally took place in two arenas – the floor (also known as the pit) of a financial exchange, or at an institution where licensed brokers manage trades on behalf of their clients. The exchange of information and placing of trades was handled by people on the floor calling out their orders, or by telephone. At first prices were written on big screens on the trade floors and sent elsewhere by telegraph. Later came electronic screens and fax transmission. While traditional trading still takes place on some exchange floors with prices appearing on giant electronic screens, the relay of information via cyberspace has revolutionised the way in which people trade. Trade desks are still equipped with telephones, but today they also feature banks of computer screens.
Why use traditional trading?
Brokers and fund managers at large institutions need to engage directly with the exchanges to execute transactions. In addition, a significant portion of private investors prefer to seek professional support and a lower risk trading environment. They usually choose traditional trading methods for these reasons:
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Broker support:
Traditional trading enables you to get support from experienced professional brokers who can help you to make the correct investment decision. Most investors enjoy a personal relationship of trust with their brokers.
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Time saving:
For people who do not have the time to manage their investments, it is convenient to leave this in the hands of their brokers.
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Long term investment:
This is still the lowest risk option of ensuring that your money will grow. Traditional trading is most suited to long-term investors who are able to keep their stock for a longer period and who have the freedom to wait until the time is right before they sell. With long-term investments, split-second timing is not a requirement as it can be with certain online transactions.
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You can trade by phone:
Trading via the Internet is not for everyone.
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Online trading >
Online trading
Thanks to the facility provided by the Internet, it is now possible for independent traders to place their own trades online. Modern trading software allows you to install your own "platform" which serves the same function as a trade floor. From here you can perform your own trading transactions without the intervention of broker.
The trade opportunities that are offered on your online platform are facilitated and controlled by a 'host' company (such as GT247.com) that supplies especially designed software and shops around to get you the best products and terms on offer. Such companies usually specialise in one or more types or classes of investment instruments, such as futures or forex. Online trading companies are required by law to be registered financial institutions and they fulfil the function of a broker.
Why trade online?
The huge advantages offered by online trading are independence, speed and convenience.
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Independence:
Online trading is great for individual investors who wish to do without the intervention of a broker. The platform in effect fulfils the function of a broker. However, although you can execute your own trades, in reality they are channelled via the trading firm's trade desk.
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Speed:
Thanks to modern Internet transmission speeds, online transactions can all be done in a matter of seconds – much quicker than picking up the phone and making a call.
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Convenience:
Online trading gives you the tools for trading literally at your fingertips and on your PC desktop. Mobile phone technology now also makes it possible to carry your trading platform with you in your pocket.
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Why would you trade?
Essentially you would do financial trading in order to borrow money, to earn money or to protect yourself from financial loss. These reasons can be divided into four main categories:
Raise Capital
Financial trading offers companies and governments the opportunity to raise money. For instance, if a company wants to raise some money for expansion, it can "list" on a stock exchange. This means that it has to register with the exchange, subject to certain requirements. It is then known as a listed company. After this it may offer its shares for sale to the public. The first release of shares for sale to the public is known as the IPO – initial public offering. The shares are then bought by investors who believe in the potential and value of the company; they expect some financial gain in the future when they eventually cash in their share certificates. These investors can also sell their shares on at a profit to other investors who believe that this is a good deal.
Another way for an institution to raise capital is to borrow money by issuing bonds. These are essentially loan agreements, whereby the investor lends money to the bond issuer, earns interest on the loan and is refunded after a fixed interval. The incentive for the investor to lend this money is that the investment will earn interest and repayment is guaranteed. So in time the investor will get his money back and will enjoy some financial gain along the way, and the institution is able to raise the capital that it needs. Governments and other large institutions use bonds to raise money to finance major expenditure such as large development projects.
Investment >
Investment
Investment is one way of trying to ensure that your money gains in value over time. In fact, the devaluation of money due to inflation is the main reason why we don't keep our savings in a box under the bed. Investors usually buy financial instruments with the intention of selling them at a later stage for financial gain. For example, when you buy a share, you aim at selling it in the future for a higher price, thereby making a profit.
When you engage in active trading of shares on the stock market, you can repeatedly buy and sell shares in order to improve your profits. So you could, for instance, sell some shares that aren't performing too well, and use the cash that you earn from the sale to buy different shares that you think will earn you more money. Or when you think your shares are at their peak in value, you could sell them and get the best possible profit, before their value begins to decline.
Speculation >
Speculation
In financial trading, the speculator makes an informed judgement about whether the price of an asset is likely to rise or fall in the future. He will then try to make a profit by purchasing when the prices are low and selling when they are high. Alternately he will try to sell when the prices are high and buy back when the prices are low, thus also making a profit. These two methods of speculation are referred to as going long or going short.
Speculation takes place largely in the futures market and the derivatives market, where private investors or independent floor traders will seek to profit from trading in financial contracts, such as Contracts for Difference (CFDs) without actually taking possession of the underlying product. Very often they hang on to the investment contract for only a short period – sometimes only for hours or even minutes if the prices are moving rapidly. In fact, in the derivatives market, contracts will have two or three expiry times per day to accommodate such short-term trading (known as intra-day trading). (Read more about trading CFDs >)
Is Speculation gambling?
A question often asked is whether speculation is a form of gambling. Traders argue that the practice of financial trading involves investing money in products that have a market value, and as such is a vital component of driving the economy. It is in essence no different from investing in any other form of goods – such as buying wholesale goods to sell at your shop – in order to make a profit. Gambling, by contrast, involves risking your money on a game of chance or on an event that in itself has no market value, and where the outcome is unknown and the odds are usually stacked against you. You can be sure that casino owners and bookmakers would not bother to offer a gaming opportunity in the first place, if the odds were not in their favour.
Hedging >
Hedging
The term comes from the concept of growing a hedge to contain an area or provide a protective barrier. In financial trading, hedging means to protect or insure against price fluctuations or financial losses. For instance, if your company expects to incur certain losses over a period of time, you might make alternative investments in order to make financial gains that could reduce your overall loss; or if you are a producer, you might sell a futures contract on your product to protect yourself against declining market prices; or as a consumer you might purchase a futures contract because you wants price certainty from your suppliers in order to accurately forecast your costs for the year ahead.
Transfer of riskHedging involves a 'transfer of risk' between two parties. To illustrate what this term means, let's look at the trading transactions between a wheat farmer and a miller. The farmer enters into a contract to sell 1,000 bushels of wheat to the miller at harvest time for R50,000. He does so because he wants to avoid the risk of earning less than R50,000 for his crop. He thus transfers that risk to the miller by entering into the contract.
The miller takes on a risk when he enters into the contract. His risk is that he might end up paying more than the going rate when he takes delivery of his order. However, he is willing to take on this risk (he has the 'appetite' for this risk) because he believes that getting in enough grain for the winter will enable him to do good business when demand is high – so security of availability is more important to him that buying for the lowest price. On the flip side of the coin, the farmer also has to weigh up the pros and cons of entering the contract. If prices rocket at harvest time, his commitment to the R50,000 deal will cause him to miss out on making a better profit. But he has the appetite for this particular risk because security of price is more important to him than the chance of a better profit.
What would you trade?
Finding a product that suits your style and level of expertise is crucial to your trading success. Some products are less volatile and easier to trade than others, ensuring a greater chance of profitability for the novice trader.
Asset classes are generally traded in Derivatives Markets.
Asset classes >
Asset Classes
Broadly speaking, financial instruments (securities) are classified in different investment categories referred to as asset classes, such as equities, commodities or currencies.
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Woolworths shares are a product that falls within the investment category or asset class of equities
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Brent Crude Oil is a product that falls under the asset class of commodities
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Trading in American dollars (USD) falls under the asset class of currencies.
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The ALSI is a product that falls into the asset class of Indices.
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Each asset class has its own investment characteristics, such as the way it behaves in the market place and its own level of risk or return on investment (ROI) (that's the yield or percentage of profit that you make). Experienced traders often develop a preference for their favourite asset classes and will choose to trade exclusively in those types.
Most traders agree that there are three main asset classes – equities, fixed-income and cash equivalents. Others also include the categories of real estate, commodities, currency (foreign exchange) and derivatives under asset classes.
Equities >
What are equities?
Equities are also known as stocks or shares. When you purchase equities, you become the owner of shares in a company – which means that you actually own a small slice of that company. This gives you certain ownership rights, such as the right to vote on decisions affecting the company and the right to receive a portion of the company's dividends. As proof of ownership, you receive share certificates, and these are regarded as a tangible asset that you have to declare to your bank if you ever have to provide a statement of assets and liabilities.
Why trade in equities?
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Long term investment opportunities
Equities provide an attractive long-term investment opportunity. Many investors will hold on to their shares for months or years and only sell when they stand to make a good profit or they need to turn their asset into cash.
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Regular income
Equities also offer a good source of regular income through the payment of dividends, which may occur as often as 3 or 4 times per year. This is particularly true in the case of 'blue chip' equities. These are shares in companies that have an established track record of steady earnings and profitable ROI. They are usually referred to as 'blue chip' companies and are regarded as a low risk investment.
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Speculation / Hedging
You can also trade on the price movements of equities in the derivatives market if you want a short-term investment for the purpose of speculation or hedging.
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Currencies >
What are currencies?
'Currency' is the term used for the money of a particular country, such as rands in South Africa or dollars in the US. When you trade in currencies you exchange one currency for another (e.g. change your rands into US dollars). Currencies are also known as forex (foreign exchange) or Fx. There are over 50 major currencies in the world and each one fluctuates in price against every other one at any given moment.
Why trade in currencies?
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Opportunity to profit
Trading in currencies provides opportunities to profit.
For example, look at what happens if you buy US dollars at the exchange rate of USD/ZAR7.5000:
Let's say that you decide to buy USD10,000. That will cost you R75,000. When the exchange rate changes to USD/ZAR7.6000 you decide to sell your dollars. You will be paid R76,000 for them. Your profit will be R1,000.
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Speculation & Hedging
Currencies can also be traded on the futures and derivatives markets and are an ideal instrument for speculation or hedging.
These markets offer leverage, which is very attractive to traders.
Leverage allows you pay only a deposit when you buy a contract, which means that you can open a position that is worth substantially more than the amount of money you have to pay.
If you gain on a leveraged contract, you stand to make a high return on investment (ROI).
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Commodities >
What are commodities?
Commodities are raw or primary products such as coffee, copper, cotton, gold, crude oil, corn, wheat, sugar, etc. When you trade in a commodity, you are buying or selling a standardised and graded unit of a certain quality and quantity, so that trades can be made without requiring a physical inspection. Many definitions of commodity use the term "fungible." This means that each unit of a commodity is identical, i.e. every bushel of No. 2 corn can be substituted for another bushel of No.2 corn. So each contract promises to deliver a specified quantity and grade (quality) of the product. Prices are quoted per kilo, per barrel, per bushel, etc. So, for example, if the price of crude oil is US$80 a barrel, because a standard contract of crude oil is 1,000 barrels, the price of one futures contract will be US$80,000.
Not all raw or primary products can be traded as commodities, because it is not practically possible to ensure that all such products meet the requirements for standardisation. Where products are differentiated they cannot be traded as commodities – e.g. one farmer's organic milk cannot be equated to another farmer's organic milk, because the organic properties can't be accurately measured.
Why trade in commodities?
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Spot market
If you are a producer or a supplier of commodities, you will buy or sell the physical goods at commodities wholesale auctions known as the spot market.
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Hedging and Speculation
Commodities are also traded for the purpose of hedging against risk and price volatility and they are equally attractive to speculators who wish to profit from price fluctuations. In this case there is no actual exchange of the physical goods, and this trading will take place on the futures and derivatives markets which offer the advantage of leverage (see above).
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Standardised specifications
Commodities are easy to trade because of their standardised specifications. All you need to be concerned about is the price and the number of contracts you want to buy or sell.
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Indices >
What are indices?
When you hear, for example, a news report stating that the market fell by 2% today, what is meant is that the performance of all the listed securities (financial instruments) on that market dropped by an average of 2%. When the average performance of a selected group of securities is measured, this group or segment is referred to as an index. And because the price movements of the top performing securities set the bar for the market, those are the ones that will be included in that index.
Some of the world's most prominent indices are:
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S&P Global 100
World's top 100 listed companies
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FTSE 100
UK top 100 listed companies
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ALSI 40
Top 40 listed companies on the Johannesburg Stock Exchange
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Nikkei 225
Japan's 225 top companies
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DOW
US industrial index of the world's top 30 industrial companies
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Sector indices
Indices are also supplied to track the performance of securities in specific sectors, such as industry, IT, mining, pharmaceuticals and technology. Some examples are the Dow Jones Industrial Average which tracks the top 30 industrial companies in the US, the Morgan Stanley Biotech Index which tracks the 36 top biotechnical companies in the US, the JSE/FTSE index for gold mining, and so forth.
Indices provide vital information to financial traders because they provide a benchmark of trends in the market. If you begin trading, you will constantly be watching the market indices to assess how they could affect the performance of your own investments.
Why trade in indices?
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Speculation
Indices also provide opportunities for profit. Just as you can speculate on the price movements of individual securities, you can also speculate on the price movement of market indices.
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Leverage
Indices are traded on the futures and derivatives markets, which offer the advantage of leverage (see above).
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Where to trade?
The market is extensive, and there are many ways in which you can trade.
Deciding where to trade has much to do with your expertise level, as well as your professional qualifications.
The Market Place >
The Market Place
Just as private commercial organisations or government organisations host agricultural product markets around the world, there are financial exchanges (such as the Johannesburg Stock Exchange or JSE) and registered financial services providers all over the world who facilitate access to the markets.
The market place consists of the following:
Exchange trading
The financial market place is made up of different exchanges where people meet to trade securities for money. Today there are more than 100 major exchanges worldwide that have become established over time as the best places to trade.
Some exchanges still conduct some of their business on the trading floor, with brokers calling out their orders. However, today most exchange trading takes place electronically, with the brokers dealing via computers. Electronic trading allows superior speed and efficiency, with orders being executed in seconds.
Most exchanges specialise certain financial markets, such as capital markets or futures markets. The Johannesburg Stock Exchange, for instance, deals in the capital and derivatives markets, while Eurex in Europe is the world's largest futures exchange.
World stock exchanges
The major stock exchanges around the world are located in the large financial capitals of the world. Not surprisingly, the New York Stock Exchange (NYSE) and the Tokyo Stock Exchange are the two largest in the world (in terms of the amount of money that is exchanged at each one). Another of the world's biggest is the NASDAQ – the National Association of Securities Dealers Automated Quotation System, which operates via an electronic computer screen-based trading system.
Some of the other largest exchanges in the world include:
Brokerages >
Brokerages
Today exchange trading is facilitated via brokers (professional traders) or brokerages (firms that offer brokering services). These are individuals or institutions that have registered with an exchange and have been issued with a licence to act as an intermediary on behalf of the exchange. They are authorised to trade the exchange's securities on behalf of their clients. Licensed institutions include firms like fund managers, commercial banks and investment banks as well as smaller brokerage firms. They employ brokers who execute trades on behalf of their clients.
A licensed broker may also provide independent, personal broking services. As an independent investor, you can use the services of a personal broker, who will act according to your wishes and place your trades for you, communicating directly with to the exchange.
Online trading firms, like Global Trader, also fulfil this function, by providing their clients with an online facility where they can personally manage their trade transactions, which are then communicated electronically via the firm's trade desk.
Over the counter trading >
Over the counter trading
Securities do not have to be traded exclusively via formal exchanges. There is also the option of over the counter (OTC) trading for those instruments that cannot be listed on an exchange because they might not meet the necessary listing requirements. For instance, a company might be too small or might not have a strong credit record. Such a company can still issue shares but it will have to trade them via brokers and dealers who deal directly with each other via computer networks. This process is called "over the counter" and such shares are usually referred to as "unlisted stock". Trading over the counter generally involves more risk, and the attraction of this is that the returns can be higher (and the losses more severe) than with lower risk investments – so OTC trading is generally favoured by more experienced traders who have the skill to take well calculated risks.
The Financial Markets
Just as there are different product markets for, say, fresh produce, seafood, meat, dairy products, diamonds, and so on, there are different categories and sub-categories of financial markets.
Each of the different markets has its own characteristics and its own way of working, and might even be limited to a particular grouping of asset classes.
We look at the basics of 6 market sectors:
What is the capital market?
The capital market has developed from the process of raising capital. In the capital market, companies and government organisations can raise money by selling equities or bonds.
Within the capital market, there is a primary market and a secondary market. The primary market is where equities and bonds are issued for sale to investors for the purpose of raising capital. This process is known as underwriting. Typically in the primary market the loan and debt agreements on equities and bonds have a longer repayment term, of no less than one year.
After the initial offering in the primary market, these securities may be traded in the secondary market. Here existing securities are bought and sold by investors for the purpose of financial gain.
Where is the capital market?
The capital market is composed of equity exchanges around the world as well as over the counter services. Bonds are mostly traded over the counter rather than on an exchange. For example, most investment institutions and brokerage firms will have a bond trading desk with dedicated bond dealers who facilitate the trade in bonds. However, some stock exchanges have a dedicated bond trading division, such as the New York Stock Exchange (NYSE) Bonds System. In South Africa bonds are sold via the Bond Exchange of South Africa (BESA) which is affiliated to the Johannesburg Stock Exchange (JSE).
Why trade in the capital market?
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The capital market offers opportunities for low-risk, long-term investment which is what characterises equities and bonds. When you buy shares in a company, for example, or buy a government bond, this kind of investment usually takes a period of time to mature and attain a profit
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Trading in the capital markets also has the advantage of the regular income that can be earned from the dividends paid out on your company shares. Many independent investors "live off" their investments – which means that the dividends they earn are sufficient to cover their cost of living.
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Bonds are interest-bearing instruments and offer a fixed income, low risk investment, which makes them very popular with financial institutions, pensions, funds, mutual funds and governments. These are buyers who need to generate investment profits without risking significant losses, and they make up what is known as the "institutional" market. The "retail" market for bonds consists of individual investors who are likely to be experienced and well informed – which is a necessary skill for negotiating commissions and spreads with retail brokers.
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Money markets >
What is the money market?
The money market deals in debt instruments (similar to bonds) that are issued by institutions that need to borrow money. The distinguishing factor of money market securities is that they are short term instruments which usually mature in less than one year.
The most commonly used money market securities are treasury bills, certificates of deposit, commercial paper, bankers' acceptances, eurodollars and repos.
Where is the money market?
The money market consists of financial institutions and dealers in money or credit who wish to either borrow or lend. These institutions include banks, especially central banks and commercial banks, mortgage institutions, fund managers, government treasuries, and large institutions with high credit ratings. They do not operate via financial exchanges, but deal directly with each other, usually with the help of specialist money market brokers.
As an individual investor, your route to investing in the money market is to buy unit trusts or mutual funds or to open a fixed deposit account with your bank.
Why trade in the money market?
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Money market securities offer some of the lowest risk opportunities available to investors. They are safe and conservative and are generally issued by institutions with high credit ratings. A typical investor in the money market might be a retirement fund or a unit trust fund. The money managers use a pool of cash (which means dealing in high denominations) gathered from their clients to invest in money market securities such as treasury bills, certificates of deposit or commercial paper.
Because such investors rely on using funds that actually belong to their clients, they have to be cautious and select the low risk options. The downside of low risk is that it means low yield. Profits on money market investments may not be as high as could be achieved through other avenues of investment, such as equities.
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Commodities market >
What is the commodities market?
This market deals in certain raw or primary products, such as coffee, copper, cotton, gold, crude oil, corn, wheat, sugar, etc. Such commodities are standardised and graded to agreed units of a certain quality and quantity, so that trades can be made without requiring a physical inspection. Not all raw or primary products can be traded as commodities, because it is not practically possible to ensure that all such products meet the requirements for standardisation.
Many definitions of commodity use the term "fungible" – this means that each unit of a commodity is identical. For example, every bushel of No. 2 corn can be substituted for another bushel of No.2 corn. Farmers who produce No.2 corn have no control over the price they will get for their corn – they have to accept the commodity market prices. Where products are differentiated they cannot be traded as commodities. For example, one farmer's organic milk cannot be equated to another farmer's organic milk, because the organic properties can't be accurately measured.
Where is the commodities market?
This market is composed of some 48 commodities exchanges around the world , such as the Chicago Board of Trade, The New York Mercantile Exchange, Eurex (the electronic European exchange) and the Tokyo Commodity Exchange. Commodities are also traded on futures and derivatives exchanges.
Commodities may also be traded over the counter (OTC), via brokers or via electronic trading platforms designed for individual investors, such as we offer at Global Trader.
Why trade in the commodities market?
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One reason for trading in commodities is to buy physical goods, which you would do at wholesale auctions known as the spot market. In this case visual inspection may be involved, and delivery takes place immediately or as soon as possible after the conclusion of the sale. Traders may use the spot market to get the physical goods that have to be delivered when their commodity contract matures.
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Other reasons for trading in the commodity market are to reduce risk, or to hedge against the possibility of price volatility, or as speculation for financial gain. In this case commodities trading falls within the scope of the derivatives market (see above).
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Foreign Exchange Market >
What is the foreign exchange market?
In essence, this market represents the transfer of money between currencies. When you exchange one currency for another (e.g. change your Rands into Euros) this activity is a part of the forex market. There are over 50 major currencies in the world and each one fluctuates in price against every other one at any given moment.
Where is the foreign exchange market?
Forex trading takes place over the counter (OTC) and banks throughout the world participate. The main trading centres are London, New York, Tokyo, Hong Kong and Singapore – which means that these are the financial capitals of the world where the greatest value in foreign exchange transactions takes place. Individual investors may trade in forex at any licensed intermediary, such as banks, bureaux de change or brokerages. Forex futures and derivatives are traded via the futures and derivatives markets.
Why trade in the foreign exchange market?
Trading in forex is necessary to support the process of international trade. For example, it enables South African businesses to import European goods and pay in Euros, even though the business's income is in ZAR. But the opportunity to profit from trading in forex also makes it a favoured trading instrument for a wide range of traders, such as banks and other financial institutions, governments, corporations and individual investors. Forex is an ideal instrument for futures trading and options trading, which makes it a good instrument for hedging or speculation.
Derivatives market >
What is the derivatives market?
The derivatives market offers opportunities to trade on the price movements of financial instruments (securities). No actual exchange is required (unlike equity trading, for example, where you can take possession of your share certificates and lock them in your safe). When you trade in derivatives you buy or sell contracts in which the price is based on the current price of the underlying asset. It is a methodology that can be applied to most asset classes. As a result, the derivatives market is huge, trading worldwide in trillions of US dollars per day. Financial institutions can use derivative contracts to create new opportunities for investment. All that is required to create a derivative contract is a willing second party.
The derivatives market trades in derivative financial instruments, like Contracts for Difference (CFDs), Options or Futures, and the underlying assets for these instruments can be asset classes such as commodities, equities, currencies, bonds, indices, interest rates, etc.
Where is the derivatives market?
This market is composed of derivative exchanges (also known as futures exchanges) such as the Chicago Mercantile Exchange (the US), Eurex (Switzerland & Germany), the LIFFE (London International Financial Futures and Options Exchange) or the South African Futures Exchange (SAFEX). Many securities exchanges deal in more than one market, and will offer trading in the capital or futures markets as well as the derivatives market. For instance, the Johannesburg Stock Exchange has a division that deals with derivatives instruments, in addition to its traditional share trading division.
Derivatives may also be traded over the counter (OTC), via brokers or via electronic trading platforms designed for individual investors, such as we offer at Global Trader.
Why trade in the derivatives market?
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Much of derivatives trading is done for the purpose of hedging in commerce and finance, to protect investments against risk and increase returns. In other words, you would minimise the risk in one investment with an 'insurance' investment in a derivative instrument.
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Some of the common uses of derivatives for hedging include farmers who hedge against falling crop prices, bankers who hedge against rising short term interest rates which could reduce their profits on loans to clients or require them to pay higher interest to their depositors, mortgage banks hedge against risks associated with bond financing, pension funds hedge against loss of value of their portfolios, and so on
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Other uses of derivatives trading are for speculation and arbitrage. Speculation involves essentially buying or selling a position with the aim of making a quick profit when the price of the contract moves in your favour. Arbitrage, on the other hand, involves investing in a specific basket of derivatives in order to ensure a "risk free" profit.
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Futures Market >
What is the futures market?
The futures market developed from the wholesale trade in commodities as a means of managing the risk of seasonal and other market fluctuations in prices. As in the case with commodities, financial futures contracts are standardised, specifying quantity, delivery month and terms.
When the futures market is played by speculators, the actual goods are not important and there is no expectation of delivery. Rather, it is the futures contract itself that is traded, since the value of that contract changes daily according the market value of the commodity.
A significant part of the futures market is also part of the derivatives market, where trading is based on the price movements of the underlying contracts.
Where is the futures market?
The futures market is organised by a number of centralized exchanges, such as the historic Chicago Mercantile Exchange or the LIFFE (London International Financial Futures and Options Exchange). Most of the world's major exchanges have a futures division. In South Africa agricultural futures (commodities) are traded via the SA Futures Exchange (SAFEX).
Futures may also be traded over the counter (OTC), via brokers or via electronic trading platforms designed for individual investors, such as we offer at Global Trader.
Why trade in the futures market?
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Futures are traded for the purposes of hedging and speculation, rather than for the purpose of actually exchanging goods. For example, both consumers and producers of commodities may hedge against price fluctuations by investing in commodity futures. Hedging by investing in futures is also a strategy widely used by financial institutions such as banks, insurance companies and pension fund companies who desire stable cash prices for their products. Futures are also an excellent tool for independent brokers and investors who wish to profit from the price fluctuations in the futures market. Speculators don't have to hold the futures contracts until the date or time of expiry – they can buy or sell at any time they want to.
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