The key to understanding financial markets definition
The key to understanding financial markets is in seeing the reasons they exist today. Why did we create financial markets? Why are we still using them today? What gives us the idea that it’s a good use of our time?
Competition. This one word is an amazing way to describe the nature of financial markets. Everything that we know about the idea of competition can be seen in the financial markets.
It’s a place where people try to learn how the world’s economy works. A place where unfair advantages do not exist. Everything about the nature of the financial markets is the knowledge and ability that people as individual traders have.
The financial markets are not for everybody. They are hard and require hours of learning, trading, making mistakes and adapting. And even after those hours of struggle, there is still no clear answer as to how the financial markets work.
The only thing people know is that they trade on financial markets only to have larger payouts. Because of this, understanding financial markets for dummies becomes even easier. It’s the centre of global economics and the reason why we can manufacture so many products. Without it, companies would fail to start new projects.
Financial markets are a global rating table, where every currency, company and resource is rated by traders to determine what it’s worth.
What are the examples of financial markets?
There are 6 versions of financial markets, but the sixth one is still being debated to this day. They are:
- Stocks (company shares)
- Bonds (lending money to the government)
- Commodities (oil, gas, gold, silver)
- Derivatives (hedge funds)
- Forex (currencies)
- Cryptocurrency (digital currency)
The reason why cryptocurrencies are still being debated is that they are new and not familiar with experienced traders. Regardless though, many people still think cryptocurrencies are a part of the 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.
Now let’s try to understand the nature of international and local financial markets. Although all of the types mentioned above are considered international, only some of them have the ability to be local as well.
International and local financial markets
The nature of international markets is that anybody can participate in them. For example, if a trader from India wants to invest in American companies, they will have to find a broker that allows such trades.
As already mentioned there are many types of international financial markets. In fact, almost all of the types listed above are considered as such. The only exception is the Bond market because it mostly involves a specific government.
Despite this, not every financial market has the ability to be local. This privilege is used only by:
Usually, this is because of laws that the country has, or the number of traders in a particular country.
What does each financial market do?
Every type of market has its own nature, values and ways it works. They all have their advantages and benefits for the economy.
- 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.
- Cryptocurrencies
- Provide alternative investments in case traditional financial markets are in a crisis.
Nature and role of financial markets
The list above shows what advantages of 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 its nature.
Stocks - 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 good. This is in most cases followed up by price increases or new projects to somehow increase the share price.
Therefore, the trader gets to directly participate in how companies price their products by simply speculating with the share price.
Forex - The role of Forex for the individual trader is pretty big. Considering that the value of something is determined by how many dollars it costs, it’s very important that the dollar itself has good value.
For example, let’s imagine that you want to buy an apple, and it costs $1. If it weren’t for the Forex market, and the daily development of global economies, that $1 would get you and $18 lunch if we calculate with 1939 standards.
You see, when the government prints more money, that 1 dollar loses some value, simply because there’s more of it now. The trading volume of a currency is usually what lets the government know that people want more dollars in the economy.
This is why Forex is a perfect example of financial market
trading nature and the things it causes.
Commodities - The role of commodities is even simpler. But in order to understand it let’s try and bring an example.
Let’s imagine that you are a very big fan of coffee and want to open a cafe in every town in the world. In order to do this, you have to buy quite a lot of coffee beans from farmers.
Let’s now imagine that there are only 5 tonnes of coffee beans available in the world, and you need about 4 tonnes to start your business. You make the deal with the farmers and make the purchase. But, you soon find out that you need just a little bit more, so you go back to buy it.
But, when you get there you find out that the price has increased already. Instead of the $1 per kilogram you were paying, it’s now $3 per kilogram. Why so?
You see, when you bought so much coffee it pretty much told the whole world that there is a really big demand for coffee, which then made the farmers raise the price because they know they can sell it. Plus, you were the one who bought most of the supply, so now we have very little coffee left, and the whole world thinks that everybody wants it.
Because of this, the price increases and the espresso that most people drink in the morning now costs three times as much because of the price of coffee beans.
Commodities are a perfect way to explain financial market trading because it helps visualize the change that one small trade can make in the world.
Through the commodities market, you as a trader will take part in changing prices for electricity, petrol, jewellery etc.
Derivatives - The derivatives market is pretty much explained fully in the list above.
Bonds - By trading bonds, you as an investor get to influence whether that big government project is going to work or not.
Things such as healthcare, infrastructure, the army or pretty much anything you can imagine as the responsibility of the government depend on the popularity of the Bond market.
Therefore, when trading bonds, people not only guarantee a nice payout but help their country in the process as well.
Cryptocurrencies - cryptos are never a part of the financial markets definition, but there are millions of people investing in them all over the world. Here’s a small example of what cryptos are usually used for.
Imagine that 2008 has repeated itself. There is a financial crisis in the whole world. Currencies are becoming less and less valuable and people generally have fewer opportunities to buy things.
The traditional financial system is unusable for a while, so what would people usually do in this case? Look for alternatives.
This is one of the reasons why cryptocurrencies were created. When there’s a crisis in the traditional financial world, the decentralized financial markets of crypto usually tend to remain a bit more stable.
But this is not always the case.