Introduction to financial markets
Introduction to financial markets
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?
- Asset classes
- What affects the markets?
- Who trades financial markets?
- Bulls vs. bears
- What is volatility?
- What is liquidity?
What are financial markets?
Financial markets are how people and companies buy and sell assets: currencies, commodities, shares, indices 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.
There are lots of different financial markets, so they’re classified into asset classes. Here’s a rundown of some you might encounter.
Also known as FX, forex markets see the buying and selling of the world’s currencies – from the British pound, to the US dollar, to the euro and more – 24 hours a day.
Commodities are physical assets that are consumed or used by people, animals, or industry. Notable examples include gold, silver, and oil.
Also known as equities or shares. When you trade stocks, you’re investing in an individual company that is listed on a stock exchange. Famous examples include Apple, BP, or Microsoft.
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.
Fixed income refers to any asset that pays the owner a set regular interest payment. The most common example is bonds, but there are numerous types of fixed income assets available.
The 'newest' asset class on the block. Cryptocurrencies are currencies that are underpinned by cryptography instead of a central bank. The most popular – and first ever – crypto is bitcoin.
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.
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 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 central bank might decide to increase money supply, making lots more currency available and causing its price to fall. Gold’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
- 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.
Pension funds, asset managers and mutual fund providers participate in financial markets to make profits for themselves and their customers.
Brokers place trades on behalf of their clients – usually retail investors and traders.
Banks mostly act like brokers for other companies, such as funds. However, some banks also participate in the markets on their own behalf.
Everyday investors and traders can participate in financial markets by buying and selling currencies, investing in commodities, and more.
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.
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.
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.
Test your knowledge
- A Bear market
- B Bull market
- C Neither
- A Trade more than ever
- B Manage your risk more carefully
- C Both
- A Highly liquid
- B Highly illiquid
- C Neither