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UK Introduction to financial markets

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Introduction to financial markets

4.5-minute read

Welcome to the FOREX.com Trading Academy. Let's get started at the very beginning – what financial markets are, and a few key concepts you need to know. 

What are financial markets?

Financial markets are how people and companies buy and sell assets: shares, indices, currencies, commodities and more.

People have traded financial markets for hundreds of years. They grew out of a practical need: to help people buy and sell things more efficiently, and to help companies that need money to raise it quickly.

Over the years, markets have grown bigger and faster, and more people than ever before are now able to get access to them. Once, they were the preserve of big banks, finance houses and very wealthy individuals. But not anymore.

Asset classes

Global traders can access an incredible range of different markets. You can speculate on obscure markets such as lean hogs, changes in interest rates and more. However, there are a handful of asset classes that most traders will stick to:

  • Shares: Also known as equities or stocks. When you trade equities, you’re investing in an individual company that is listed on a stock exchange. Famous examples include Apple, BP or Microsoft.
  • Indices: An index tracks the price of a group of shares. For example, the S&P 500 (US 500) – one of the most widely traded indices globally – is a measurement of some of the largest listed companies in the US.
  • Currencies: Also known as forex or FX, currency markets see the buying and selling of the world’s currencies – from the Great British pound, to the US dollar, to the Hungarian forint and more – 24 hours a day.
  • Commodities: Commodities are physical assets that are consumed or used by people, animals or industry. Notable examples include oil, gold and wheat.

What affects the markets?

Each asset will have its own unique factors that affect its price, but every market’s price is driven first and foremost by the fundamental principle of supply and demand.

Demand is how many people are trying to buy a financial market. If demand for a market is low but supply is high, its price will drop.

If demand then rises (but supply doesn’t) its price will usually rise.

Supply

Supply is how much of a financial market is available for purchase. If lots of people want to buy something but supply is limited, its price will rise.

If supply then rises (but demand doesn’t) its price will usually fall.

Demand

Demand is how many people are trying to buy a financial market. If demand for a market is low but supply is high, its price will drop.

If demand then rises (but supply doesn’t) its price will usually rise.

Lots of different things can cause supply to fluctuate for a financial asset. For example, a large shareholder in a business may decide to sell their stock – flooding the market with shares and causing their price to fall. Oil’s supply, on the other hand, is dependent on a wide range of companies, institutions and countries around the globe.

On the demand side, a few important factors to watch out for include:

  • News: Many market participants keep tabs on the news in real-time; positive or negative headlines affecting a market can quickly drive supply or demand down
  • Central bank policy: Central bank decisions – such as interest rate changes – can have a profound effect on the flow of money around the world, and will have a significant impact on demand
  • Company results: Companies listed on stock exchanges will release regular results which will encourage investors to buy or sell their share
  • Government data: Government releases can affect demand. Unemployment information or inflation data, for example, offer insight into the strength of an economy – which may make it more attractive to investors

Who trades financial markets?

There are a wide range of people and companies that buy and sell financial markets.

Institutional investors

Pension funds, asset managers and mutual fund providers participate in financial markets to make profits for themselves and their customers.

Brokers

Brokers place trades on behalf of their clients – usually retail investors and traders.

Banks

Banks mostly act like brokers for other companies, such as funds. However, some banks also participate in the markets on their own behalf.

Retail investors

Everyday investors and traders can participate in financial markets through investing in funds, buying shares, or actively trading the markets through spread bets and CFDs.

Before we take a look at each asset class in more detail, there are a few important concepts that underpin how markets work: bulls and bears, volatility and liquidity.

Bulls vs. bears

You'll often see financial markets represented as a battle between bulls and bears. Bulls are market participants with a positive view of an asset. Bears are the opposite, believing an asset is overpriced.

Illustration of Bulls vs Bears to show market types on FOREX.com UK trading course

When bulls outnumber bears in a market, lots of people will be trying to buy. So, demand is high, and may be outstripping supply. This causes a bull market, with prices rising to new highs.

On the other hand, when bears outnumber bulls, lots of people will be trying to sell. This creates low demand and can increase supply – leading to a bear market, with prices moving lower.

What is volatility?

Volatility is how much an asset’s price will swing up and down over a period. Bears and bulls rarely have total control over a market. Instead, its price will oscillate as one group then another takes over.

Illustration of a volatile trading view chart

Look at almost any market’s price chart, and you’ll see volatility in action. Highly volatile markets see significant moves, which create lots of profit opportunities – but will also bring increased risk. Traders with a high risk-appetite might look for volatile assets, while the more risk-averse will invest in markets that typical see less severe price movement.

What is liquidity?

Liquidity is how easily a financial market can be bought or sold. If an asset has lots of potential buyers and sellers at any given time, then it is highly liquid, and you should be able to trade it easily without affecting its price too much.

If buyers and sellers are scarce, on the other hand, you may struggle to find a suitable trade.

Liquidity is an important factor in financial markets. It enables traders to move quicker and keeps prices competitive. Less liquid markets are generally perceived to be riskier than highly liquid ones.

Liquidity and volatility in forex

Watch our video to learn how volatility and liquidity work in forex – the world’s most-traded market.

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Test your knowledge

Question 1 of 3
UK Apple shares hit a new high of $130, then rise again to $140 within a week. Is this a:
  • A Bear market
  • B Bull market
  • C Neither 
Question 2 of 3
When volatility is high, is it a good idea to:
  • A Trade more than ever
  • B Manage your risk more carefully
  • C Both
Question 3 of 3
The currency markets see higher trading volume each day than any other asset class. Does this make them:
  • A Highly liquid
  • B Highly illiquid
  • C Neither