What is trading?

Definition of trading

Trading is the act of buying and selling financial instruments with the goal of making a profit. There are many different types of trading depending on the asset class and strategy, including:

• Forex trading: Global currencies are traded on the foreign exchange (FX) market, which is the largest and most liquid market in the world. Popular currency pairs to trade include the EUR/USD and GBP/USD.
• Stock trading: Stock trading involves buying and selling shares of publicly traded companies, such as Apple or Tesla, with the aim of profiting from changes in the stock’s market price.
• Commodities trading: Commodities include raw materials like crude oil, gold, natural gas, wheat, or coffee. Commodities traders use futures or other derivatives to speculate on price movements in these markets.
• Indices trading: Indices are groups of stocks that reflect the overall performance of a sector or economy. Examples include the S&P 500, Dow Jones Industrial Average, and FTSE 100. Instead of trading individual stocks, indices allow traders to speculate on the direction of an entire market.
• ETF trading: Exchange-traded funds (ETFs) bundle multiple assets into a single investment. They can track indices, commodities, currencies, or sectors, allowing traders to gain broad market exposure through a single product.
• Options trading: Options are derivatives that give traders the right, but not the obligation, to buy or sell an underlying asset at a set price before a specific date. They’re often used to hedge risk or take leveraged positions with limited upfront capital.

History of trading

Trading is not a new concept – it’s one of the oldest human activities dating back thousands of years to when humans exchanged goods with nearby communities.

Prehistory

The earliest evidence of trading is in prehistoric times, when early humans exchanged goods like tools, food, and materials through basic bartering systems. The very first example we know of was during the Stone Age, where obsidian – a volcanic glass used to make tools – was traded across hundreds of kilometers.

Ancient history

By the time of the earliest civilisations, trade had become more organised and structured. The Sumerians, for example, traded with distant regions in the Indus Valley and used clay tokens to record transactions.

The Phoenicians and Greeks expanded maritime trade across the Mediterranean, and the Romans built extensive trade networks across Europe, North Africa, and Asia. These civilisations also helped establish currency, weights, and trade laws, tools that we still use in commerce today.

Middle Ages

In medieval Europe, trade evolved through hand-to-hand markets and trade fairs. Cities like Venice and Genoa became major trading hubs that facilitated the exchange of goods between Europe and the Middle East.

During this same period, trade was thriving along the Silk Road, which connected China, Central Asia, and the Islamic World. In fact, Central Asia was the economic center of the world during the Middle Ages.

The age of sail and the industrial revolution

From the 15th century onwards, trade evolved through colonisation and maritime exploration. European powers like Portugal, Britain, and the Netherlands established trading empires that would exchange goods such as spices, gold, textiles, and eventually industrial products. Most of the global trade at this time was facilitated by colonial economies and new shipping routes.

The Industrial Revolution and its innovations in manufacturing and transportation expanded trade on a massive scale, allowing goods to move further, faster, and more cheaply than ever before. By the 19th century, stock exchanges were becoming the formal standard for trading company shares.

Everything seemed on the up until the Great Depression in the 1930s, which showed the world how trade restrictions could destabilise the economy. In response, international agreements, like the Bretton Woods system, were created to promote free trade and financial cooperation.

Today, trading spans a wide range of markets, from physical commodities like oil and precious metals to financial instruments like currencies, stocks, and derivatives. Thanks to technological advancements, traders can easily buy and sell across borders in real time, moving the markets faster than ever before.

Types of trading

There are many different forms of trading, but three of the most popular are stock, forex, and commodities trading.

Stock trading

Stock trading involves buying and selling shares of publicly listed companies. When you buy a stock, you become a partial owner of that company with a claim to a share of its profits and assets. Some companies also pay regular profit distributions (called dividends) to their shareholders, which can provide a passive income stream.

Stock traders aim to profit by buying shares at a lower price and selling them at a higher price. These transactions often happen on major stock exchanges like the NYSE or Nasdaq during specific trading hours.

Forex trading

Foreign exchange (forex) trading involves exchanging one currency for another with the goal of profiting from changes in exchange rates. The forex market is the largest and most liquid financial market in the world, with more than $6 trillion traded each day.

Forex is traded in currency pairs, where one currency is bought while the other sold (e.g. EUR/USD or GBP/JPY). The forex market is different to the stock market in that it operates 24 hours a day, five days a week.

Commodities trading

Commodity trading involves buying and selling physical goods like oil, gold, agricultural products, or industrial metals. These are usually traded via futures contracts or other derivatives, which allow traders to speculate on price movements without having to take physical delivery of the goods themselves.

Commodities are divided into two categories:

• Hard commodities: These are natural resources like crude oil, silver, gold, and copper.
• Soft commodities: These are cultivated agricultural goods like wheat, coffee, corn, and livestock.

Trading vs investing

Trading and investing are often used interchangeably, but they are two different activities.

Traders aim to profit from buying low and selling high (going long) or selling high and buying low (going short), usually in a short to medium-term timespan. Many traders use derivatives like CFDs or options, which provide leverage but also carry higher risk.

Investors, on the other hand, buy assets and hold them for the long term. The hope is to generate returns through price appreciation and reinvesting dividends over time.

To put it simply, traders are focused on short-term price movements while investors are motivated by longer-term gains.

How trading works

Trading involves speculating on the price movement of a financial asset (e.g. stocks, currencies, commodities, indices). If the market moves in the direction you’ve predicted, your position makes a profit. If it moves the opposite way, you incur a loss.

At its very core, trading works on the principles of supply and demand. When there are more buyers than sellers in the stock market, for example, stock prices go up, and when there are more sellers than buyers, stock prices fall. Supply and demand in trading can be affected by everything from market trends and geopolitical events to natural disasters and tech developments.

Mechanisms of trading

Most trades are executed either over-the-counter (OTC) or through an exchange:

• OTC trading: This is a trade made directly between two parties (trader and broker) outside of a central exchange. Prices are negotiated based on real-time market conditions.
• Exchange trading: These trades take place on regulated marketplaces like the New York Stock Exchange (NYSE) or CME, where prices are transparent and orders are matched automatically.

Traders place orders using a trading platform, where they can choose from different order types:

• Market orders: Execute immediately at the best available price
• Limit orders: Execute only at a specified price or better
• Stop-loss and take-profit orders: Automatically close trades once a specific price is reached to limit losses or secure gains.

Market participants

Trading involves many players, known as ‘market participants’. These include:

• Retail traders: Individual traders who use online platforms to speculate in the markets.
• Institutional traders: Large firms like hedge funds, mutual funds, pension funds, insurance companies, or asset managers trading in large volumes.
• Brokers: Intermediaries who execute trades on behalf of clients and offer trading platforms, analysis tools, and leverage through a margin trading account. There are both offline and online brokers.
• Market makers: Entities that provide liquidity by continuously quoting buy and sell prices.

Trading strategies

Traders can use different strategies depending on their goals, risk tolerance, and time horizon. The most common trading strategies are day trading, swing trading, and position trading:

• Day trading: This is when positions are opened and closed within the same trading day. Day traders focus on short-term price movements, using charts and technical analysis to spot ideal entry and exit positions.
• Swing trading: This is when trades are held for several days or weeks, with the aim of capturing short to medium-term price movements. Because trades are held longer, swing traders use tools like risk/reward ratio and stop-loss to manage risk.
• Position trading: This is a longer-term approach that involves holding positions for weeks, months, or sometimes even years. Position traders identify specific trends and potential profitable entry points then maintain their position until the trend breaks.

Advantages and disadvantages of trading

Trading can offer great opportunities for returns, but it also comes with certain risks. Below, we look at the advantages and disadvantages of trading.

Advantages

The benefits of trading include:

• Potential profit: Most traders do what they do because of the profit potential. With the right strategy and timing, traders can benefit from both upward and downward market trends and earn returns faster than through traditional investing.
• Liquidity: Most major markets offer high liquidity, which means traders can enter and exit positions quickly and with minimal price impact.
• Flexibility: Traders can choose a trading style and market that works for them, whether that’s day trading stocks or holding longer-term positions in commodities.
• Diversification: Trading allows access to a wide range of asset classes, including currencies, stocks, commodities, and indices, which can help spread risk across different market types.
• Tech and tools: These days, online trading platforms offer numerous tools that make trading more efficient and accessible, including real-time data, charting tools, and order execution features.

Disadvantages

Despite the earning potential, trading does have certain drawbacks. These include:

• High risk: Trading, like investing, involves risk. Market volatility can be unpredictable and lead to losses. The risk is especially high with leveraged trading, which can magnify potential losses beyond the initial investment.
• Complexity: Trading isn’t necessarily easy. It requires a solid understanding of financial markets, technical indicators, and risk management, and traders need to continuously update either knowledge to adapt to changing market conditions.
• Time commitment: It takes time to develop and execute a trading strategy. Active trading, in particular, requires frequent monitoring of the markets and quick decision-making, which might not be for everyone.
• No guarantees: Even the most experienced traders, with the most well-considered strategies, experience losses. There’s never a guaranteed outcome in trading.

Disclaimer: FOREX.com Australia are a Contracts for Difference (CFD) issuer and our products are traded off exchange. We do not offer direct ownership of the product and exposure to the assets mentioned is available solely via Contracts for Difference (CFDs). This material relates to the underlying asset and does not constitute a recommendation or offer to trade.