Are you trying to figure out the financial markets and the assets included to trade and invest with? Well, our ultimate guide introduces you to the world financial markets, including the definition of financial markets, their classification, and more.
What is a Financial Market?
As the name says, a financial market is an exchange marketplace where trading or buying and selling of financial securities occur. These securities are also referred to as financial instruments, and they include forex, stocks, bonds, commodities, cryptocurrencies, derivatives, and more. It can also be used by businesses to raise capital and reduce risks.
Understanding Financial Markets
Financial markets are sometimes known as capital markets. They accommodate businesses or investors trying to raise money and are critical to the seamless operations of capitalist economies. This means that whenever a financial market fails, it can result in disruptions in the economy, including recession, inflation, and even unemployment.
Independent regulatory authorities oversee the performances of the financial markets. These authorities have stringent regulations to ensure businesses and investors manage their activities under the best conditions. Any violation by authorised bodies, whether brokerage companies or financial institutions, can attract heavy penalties and even license cancellation.
Types of Financial Markets
There are many forms of financial exchange globally, and every country hosts at least one even though they vary in size. So, if you are among the individuals who thought that the stock market is the only financial market, well, there are more.
Financial markets accomplish different goals, the main one being exchanging various products to increase liquidity. This allows traders to have an opportunity to make money from buying and selling of the assets.
That being said, here are the types of financial markets and their functions.
- Stock Markets
The stock market is the most popular type of market, which is why it is widespread globally. It is a place where companies list their shares to be bought by traders or investors through brokerage firms. Note that each share comes with a price tag, and traders and investors can profit from them if their performance in the market turns out positive.
The stock markets are also known as the equities markets and are used by various companies globally to raise money through an Initial Public Offering (IPO). You get to trade stocks on multiple exchanges listed in the markets, such as the New York Stock Exchange (NYSE), London Stock Exchange, and NASDAQ. Most countries globally have stock exchanges, so confirm if your country hosts one before venturing into stocks.
It is essential that you trade stocks on a regulated stock exchange since it benefits the economy hence providing dividends and capital gains to investors. However, stocks can also be traded over the counter, meaning that it is conducted between the buyer and seller only. There is no supervision from a stock exchange.
To learn more about Stock Brokers and Stock Trading Apps, please check our other guides.
- Currency Markets
The currency market is also known as the foreign exchange (forex) market. Here, traders get to buy and sell currency pairs. They can also hedge and speculate on the currencies’ prices and make profits should their trades work in their favour.
Note that the currency market is the most liquid globally, considering that cash is the most liquid global asset. Because of this, the market has attracted millions of traders to try their luck resulting in over $5 trillion daily transactions. It is also a decentralised market, hosting thousands of brokerage firms with which we highly recommend you trade with. However, you must be keen on your choice of a broker and consider your trading interests.
The forex market also hosts other financial institutions such as banks, commercial companies, investment institutions, hedge funds, and more. Demand and supply of currencies are the main driving factors to a currency’s exchange rate. Therefore, you need to be sure of the currency to trade if you want to profit from this market.
Learn more about UK Forex Trading Apps and UK Forex Brokers in our other guides.
- Over-the-Counter Markets
Like the forex or currency markets, over-the-counter (OTC) markets are also decentralised. This means that you get to trade electronically, and there is no specific physical location. Traders also conduct their businesses without the interference of a third party, which in this case is a broker.
You can trade various assets such as stocks that do not qualify to be listed in exchanges over the counter. There are also other derivatives to trade over the counter, including forwards, swaps, exotic options, and more. Simply put, over-the-counter markets and the trading activities conducted in them are mostly unregulated and less liquid.
- Bonds Markets
Bond markets are places where large businesses or investors obtain huge loans for certain periods at specific rates. A bond is like an agreement between the participating parties (the borrower and the lender) containing all loan details, including dates and payment plans.
Business corporations are responsible for issuing bonds to investors and other businesses. You can also acquire bonds from states, sovereign governments, and municipalities to finance your operations.
The value of bonds increases with decreasing stock prices and vice versa. They also provide liquidity to help the economy run seamlessly.
- Money Markets
The money market is a type of financial market that trades with highly liquid products. These products have less than one year of maturities with low-interest returns. This market accommodates traders or businesses with temporary excess funds and their counterparts with shortage of funds and willing to borrow.
In this market, you can borrow funds within a short timeframe through a standard tool known as call money, which usually lasts up to two weeks. Financial institutions can also borrow funds through the interbank market, which lasts between weeks to one year. The instruments used in this financial market are treasury bills, bills of exchange, commercial papers, and more.
- Commodities Markets
This market is the meeting place for producers and consumers of commodities, including agricultural produce, energy products like oil and gas, precious metals like gold, or soft commodities like cotton, sugar, and coffee. Also known as a spot commodity market, you get to trade physical assets and profit from the price difference.
The commodities market hosts highly volatile assets. For this reason, companies can lock in prices of given commodities today that are to be delivered at a future date in a commodities futures market. In return, the commodities futures markets reduce volatility in the trading assets, which gives room for total control of specific commodities’ future prices.
You can also trade commodities on derivatives markets using spot commodities as your underlying assets. In addition, options and forwards on commodities are exchanged over the counter and on listed exchanges globally.
- Derivatives Markets
A derivative is like a contract between parties whose value is based on the market value of the underlying asset being traded. They are complicated financial instruments used by investors and hedge funds to maximise their potential profits. What’s more, derivatives markets can be traded over the counter or through exchange-traded derivatives.
Simply put, derivatives are secondary trading instruments derived from the primary securities linked to them. These primary securities can be stocks, currencies, commodities, bonds, indices, and more. They help control any foreseen financial risks, and you can trade them as futures, options, swaps, and forward contracts.
- Cryptocurrency Markets
Cryptocurrencies are taking over the financial markets by storm, mainly because they are decentralised digital assets based on blockchain technology. There are hundreds of cryptocurrencies to trade with on cryptocurrency exchanges, including Bitcoin, Ethereum, Litecoin, Ripple, to name a few.
The reason why cryptocurrencies are traded on exchanges is that exchanges have digital wallets that enable traders to easily exchange a currency for another. You can also exchange a cryptocurrency with fiat money such as the US dollar and more.
Read about the Elliott Wave Theory to catch tops and bottoms in the market.
Classification of Financial Markets
If you are trying to figure out the types of financial markets, then it is also important to note that they are classified into four different categories. Below are how they are classified.
- By Nature of Claim: These are financial markets that are categorised based on claims investors have on already invested assets. The claims can either be fixed or residual and conducted on markets such as debt and equity markets.
- By Maturity of Claim: Time periods are an essential part of an investment since the amount you will invest will depend on the time which you plan to hold your investment. This means that short periods carry lower risks and long periods have higher risks. The type of markets based on the maturity of claim include the money and capital markets.
- By Timing of Delivery: This category of financial markets applies in the stock markets or secondary markets such as the futures and cash markets.
- By Organizational Structure: Here, markets are classified based on the ways transactions are made in the financial markets. These markets are over-the-counter markets and exchange-traded markets.
Functions of Financial Markets and Institutions
From our overview of financial markets above, financial markets and institutions play important roles in the stability of the economy. Take a look below at their functions.
- Securities’ Prices Determination
The prices of instruments you trade with are determined in the financial markets. This is mainly due to the forces of demand and supply on these assets being bought and sold by traders. Simply put, the financial markets provide a tool for which assets’ prices are set.
- Puts Savings into Productive use
Instead of money sitting in various investment accounts without use, the financial markets mobilize these funds and avail them to borrowers or debtors. It does so by connecting lenders with borrowers, resulting in economic stability. Financial markets can also issue financial instruments to traders and investors to make profits using their savings.
- Ensures Liquidity
Traders or investors look for liquid assets to trade, and the financial markets ensure that these assets are available. Trading with liquid assets allows you to easily convert the assets into cash should you see an opportunity to make profits.
Note that sometimes the financial markets can lack liquidity, forcing you to hold onto an asset until the condition changes. Therefore, before trading or investing, ensure you fully understand the previous performances of an asset and the period you plan to trade (whether long-term or short-term).
- Saves Money
The financial markets are public, and so they provide ways to set trading assets’ prices. For this reason, you do not need to spend your money acquiring information on the assets that are freely available on the financial markets. In addition, there are a plethora of transactions on the financial markets, helping them to quickly achieve economies of scale. As a result, you get to trade or invest at low costs.
- Easy Access
Traders and investors are always looking for opportunities to make profits. In this regard, the financial markets help buyers and sellers meet to achieve their objectives. This saves time that could have been used to find a buyer or seller.
Сonclusion
The investing and financial markets are the best platforms for traders and investors to conduct their businesses under the best conditions. Although they may or may not have physical locations, you get access to trading capital. Financial markets also offer a plethora of assets that you can take advantage of and try to profit from them.
Generally, financial markets give investors opportunities to make profits by allocating limited resources in a particular country. It gathers funds between traders and investors and helps determine the prices of trading assets. This ensures liquidity and volatility in trading assets, giving you a chance to profit from them.
Note that trading financial instruments require regulated brokers who act as intermediaries that bring traders together. You will pay commission or spread for their services, so it is crucial that you consider various elements when choosing a broker, including trading costs, trading tools, and more.
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25,000 hours of testing 70+ brokers. Our recommended broker is Plus500.
Our recommended broker is Plus500.
Trading can sometimes be very risky for beginners! Be careful
If a broker has been around for a long period of time, they’re likely to be more reliable (in comparison, most scam brokers only exist for several years before they disappear). This also suggests that a broker has good risk management processes that have prevented them from being caught out by major financial events.