Financial markets definition - what is their nature?

Any marketplace where trading of securities takes place is called a financial market. There are various types of securities, such as currency pairs, physical and CFD stocks, commodities, bonds, etc. Each financial market has its own characteristics.
Financial markets are a part of the modern world. While some might argue that they are not perfect, they are the best systems that we currently have.
Financial markets help funds to be moved from investors to those who need capital. The markets are highly efficient and competitive. Investing in financial markets helps investors protect their wealth from inflation and grow capital by compounding. On the receiving end are businesses and publicly traded corporations that use financial markets to sell shares and receive funding. The funds are then used for expansion. More products are created that create wealth and everybody wins.
However, many speculators and investors lose money trading financial instruments. The markets punish participants who misjudge the situation and make wrong investments. Which is why it’s essential to understand the nature of various financial markets.

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The key to understanding financial markets

Understanding financial markets

Financial markets are the engine of modern-day capitalism. The financial market's meaning can be different for different people and institutions. For investment funds, pension funds, and hedge funds, markets are the main place to make long-term investments. For retail and institutional speculators, markets are a way to make money short term. Governments, Banks, and corporations use the Forex market to exchange currencies. The list of participants is endless. 

If you ask an economist, why is making money difficult, he or she will reply that the main reason is competition. Many people are competing with each other to increase their wealth. This is even more prevailing in the financial markets. Yes, some people gamble with their money making random investment decisions, but the main goal of speculators and investors is to make money. The nature of international financial markets is digital, fast, and massive. Which means that you need to be one step ahead of the crowd to make money. Getting financial knowledge and developing the ability to make investments on your own can help you grow your wealth. However, keep in mind that the financial markets are not for everybody. Investing is hard and requires hours of learning, trading, making mistakes, learning from them, and adapting.

What are the examples of financial markets?

There are 5 versions of financial markets:
  • Stocks (company shares)
  • Bonds (lending money to the government)
  • Commodities (oil, gas, gold, silver)
  • Derivatives (hedge funds)
  • Forex (currencies)Types of international financial markets
As you can see, there are many types of financial markets, but it’s not something to be scared of. Usually, when a person is starting to trade, they choose only one financial market to focus on. But, that doesn’t mean people can’t trade on all of them. The nature of international markets is that anybody can participate in them, the internet and digitization of financial markets have made participation easier. Which in turn is great for the markets as liquidity is higher than before. For example, if a trader from India wants to invest in American companies, they will have to find a broker that allows such trades

What does each financial market do?

Every type of market has its characteristics. Each market has different pros and cons for investors.
  • Stocks
    • Allows companies to sell parts of their income and gather funds for new projects.
  • Forex
    • Allows the economy to grow based on currency value.
  • Bonds
    • Allows governments to fund new projects by offering better payouts in the future.
  • Derivatives
    • Helps companies to optimize the risk exposure and lets people speculate.
  • Commodities
    • Regulates the prices of raw materials, which are then used to manufacture goods.

Nature and role of financial markets

The list above shows what advantages financial market trading brings to the economy in general. However, the advantage to the trader him/herself still needs to be defined.

In this paragraph, we will take a look at what traders as individuals gain from financial markets and how they influence their nature. Let's take a look at financial markets examples and learn how they work.

Stocks – Stocks are issued by companies to get funding and expand. Private companies go public in IPOs. IPOs help small companies to become global. The nature and role of the stock market are to determine the value of a particular company. If the company has few shares available for sale, but the price is very low, that’s usually a signal that the company isn’t doing too well. This is in most cases followed up by price increases or new projects to somehow increase the share price. Stock markets are centralized, which means that for trading certain company shares, you need to be investing during an active trading session. Each exchange has its trading hours. It's important to note that there are physical stocks and stocks as CFDs. Physical stocks are a preferred choice of long-term investors. For short-term profits, speculators trade stocks as CFDs. CFD stands for Contract For Difference, which makes short selling possible. Speculators can benefit from shorting stock CFDs. 

Forex – Forex is the largest and the most liquid market in the world. Currency trading is decentralized, which means that when one exchange closes, you can still trade Forex in another one. Forex markets are open 24/5. However, it's worth mentioning that Tokyo and Sydney trading hours are not as active as London and New York. Both retail and institutional Forex traders are providing liquidity for banks, governments and other participants. How is Forex trading benefiting you as a non-Forex trader? Every time you go to a vacation in Rome and exchange local currency to Euro, you can thank the Forex market for low spreads. 

Commodities – Commodities are raw materials that can be grown or mined. Trading commodities increases liquidity and creates a more risk-free environment for commodity producers. Investors can invest in commodities in various ways. They can purchase physical precious metals, purchase commodities as CFDs, or invest in companies that produce commodities. The commodity market is highly influenced by demand and supply. For instance, in times of war and political instability, demand and therefore the price of oil increases. Global warming damaged food production and commodities such as wheat went up in value. Traders who are aiming to invest in commodities, need to study the global economy. Commodities are strongly tied to the economy as a whole. Even if you are only going to trade currency pairs, learning about commodity markets can help you make more informed decisions. OPEC countries are largely dependent on the revenues made by exporting oil. If you are trading a currency pair that is highly correlated to oil prices, you should be keeping an eye on energy prices. Currencies that are dependent on commodity prices are called commodity pairs. 

Through the commodities market, you as a trader will take part in changing prices for electricity, petrol, jewelry, etc.

Bonds – The bond market is considered to be safer than other financial markets. Bonds are issued by governments and large corporations. The low-risk assets are characterized by low returns.

Criticism of modern day financial systems

People that criticize modern financial institutions, emphasized the fact that speculators do not create an actual product. They get rich by taking from other people. However, this might be an exaggeration. Traders are actively involved in price creation, they provide increased liquidity to Banks and other institutions. Speculators move funds from infective businesses to effective ones and get rewarded for it. Big businesses use funds received from financial markets to increase production through automation and create wealth. Money is not real wealth. If you print more money and give it to the world, the world will remain poor. The only thing that will change is inflation. The real wealth is created by the businesses that build products and offer services.

It's worth mentioning that modern financial markets help assets grow in price drastically and drop sharply. Thanks to digitalization, printing money from thin air, and globalization, inflating financial bubbles has become easier. For passive investors who are not following market developments closely, investing in such markets might become costly. The best way to protect your investments is to stay informed.

Demystifying Derivatives: Understanding Complex Financial Instruments

Derivatives are complex financial instruments that require a deep dive to understand correctly. Major financial markets including Forex offer various types of derivatives, making it crucial for traders to understand what these asset types represent. Derivatives are financial contracts whose value is derived from an underlying asset, index, or even rate. Derivatives play a significant role in modern financial markets, as millions of traders are speculating on these assets, often without the need to own underlying securities. 

Options and futures

The list of popular derivatives includes futures contracts, options, swaps, forward contracts, interest rate derivatives, and more. 

Futures and options are very popular derivative markets, where billions of dollars are traded daily. While not as gigantic as Forex markets, options and futures markets are significant contributors to global financial market share. Options are derivatives that provide the holder with the right, but not the obligation, to buy (call option) or sell (put option) an underlying asset at a predetermined price (strike price) within a specific time frame. In essence, traders usually use options to make profits from price movements, and they rarely use options to buy the underlying asset. Unlike options, futures oblige the two parties to buy or sell the asset at a certain date and price. 

CFDs demystified

In Forex markets, the most popular forms of derivatives are CFDs or Contracts for Difference. In many cases, Forex brokers typically offer the majority of their trading instruments in different asset classes using CFDs. CFDs allow traders to speculate on the price of an asset without actually owning it. Forex CFDs, in this case, are currency pairs that can be traded without owning the underlying currency pair. 

While being criticized and even prohibited in the United States, CFDs can be super beneficial for specific assets like cryptocurrencies. The main reason why it is much more flexible to trade crypto CFDs instead of actual digital currencies is their execution speeds. CFDs are typically lightning-fast and allow traders to instantly speculate and make profits from short-term movements. Cryptos require network confirmation from the blockchain, which makes them much slower when compared to CFDs. 

However, there is a dark side to CFDs as well, as they are highly risky assets and traders can experience substantial losses if they are not carefully controlling their risks. CFDs usually come with higher leverage levels that can amplify potential profits manyfold. The same is true for losses, and traders must employ well-implemented risk management strategies to limit losses. The most basic risk management tool that is also very potent in this regard is to always use stop loss in all trading activities. 

Binary options explained

One type of derivative is especially dangerous. The binary options are derivatives that allow traders to bet on where the price will be at the predetermined time when compared to the current price of an asset. Traders can buy put and call binary options instead of going long or short, and they come with expiration times and dates. Binary options are usually offered for Forex pairs and are prohibited in many countries because they resemble gambling.

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Financial markets explained – key takeaways

The key takeaway of this guide is that financial markets are what keep our world working. The exchange of goods, currencies, promises and future opportunities regulate how and why things are priced the way they are. Markets provide liquidity, move funds from investors to businesses, and create wealth. 

What are financial markets

Each market has its characteristics. Trading hours, liquidity and exchange types are different. Physical stocks are generally used for long term investing. While CFDs such as Forex, CFDs for stocks, commodities, indices, etc. are best for short term speculations. Bond markets are considered to be safer than other markets, consequently, returns are typically lower. 

FAQ on Financial markets definition

Why are financial markets important?

Financial markets are critical because they regulate how the economy works in the world. They are the reason prices change and how they change.

The more active people are on the markets, the higher the price is going to get, but if people start ignoring it, then prices can decrease so much that a crisis may start.

The financial markets are what typically support large corporations to remain large, therefore giving a lot of people jobs and opportunities to develop themselves as well as help their families.

How to learn about financial markets?

There are a lot of ways to learn about what is a financial market, but some are better than others. There are many experts today, and almost all of them have had a unique learning experience, so there’s no real “default” learning strategy.

Usually, beginners start with reading guides, learning the slang of financial markets, the abbreviations, and tools that they can use.

The other option is sometimes to just start trading right away and learning as they go, but that’s typically much harder.

The most popular method is trying a small piece of every strategy. This helps the trader try everything out before devoting himself or herself to one method. Once they’ve found their perfect solution, they focus a lot of attention on it.

How does the financial market work?

Modern financial market works digitally, and it connects buyers and sellers. The market participants create liquidity and move funds from investors to business. In turn, businesses create goods and services on a large scale and create wealth. It's worth mentioning that investors and speculators that make wrong predictions lose money, while traders that are good at their job tend to make money.

How do I select a financial market?

It depends on your preference. If you are a beginner, it's great to learn about different markets, try them and find the ones that work best for you. Most brokers offer free demo accounts. However, Forex markets are the most accessible due to the large number of Forex brokers and small barriers for entry. Stock markets are great if you are planning to invest long term. For short term profits, you can trade CFDs.

Can I trade on financial markets from home?

Yes, as we've already mentioned, global financial markets are highly digitalized. You can trade currencies, stocks, commodities, bonds, etc. from your bedroom. However, keep in mind that investing profitably requires experience, dedication and hard work. Many people manage to turn investing to their main source of income, while others lose money.

Can I influence an asset's price on the markets?

Yes, anyone can influence the price of an asset on the market, but the effect will not be visible unless you are investing a lot of money. Modern financial markets are highly liquid. Which is great for retail traders. It means that there's always a buyer and seller out there to trade with you. 

What is the nature and importance of a financial market that exchanges currencies?

The nature and importance of financial markets with currency exchange is pretty huge in the entire trading industry. The daily capital flow in Forex reaches multiple trillion US dollars, and it also has the highest liquidity levels. Because of this nature of the financial system, Forex counts over 10 million traders globally.

But Forex isn't just about financial trading. Here is a real-life example to better demonstrate what is a financial market importance for us: If you travel abroad, you most probably need to sell a certain amount of your native currency and buy one that's being used in your country of destination. With its exchange rate, bid and ask prices, and commission charges, this real-life exchange is nothing but an integral part of the Forex financial market definition.
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