Financial instruments for successful trading
A financial or trading instrument is a document representing an agreement between two parties receiving certain financial assets or obligations. They are securities, stocks, bonds, options, futures, derivatives, etc. In trading a financial instrument is usually ownership of tangible or intangible assets that have a certain value (this value is formed as a result of trading). The choice of a financial instrument depends on liquidity, dynamics of price movements, trading strategy and acceptable risk. Below you can read about the most popular of them.
Stocks
A stock is a security issued by a joint-stock company – the issuing company. All investors who buy stocks become co-owners of the company. These stocks confirm that its owner has a stake in the company, even if it is very small. Trading in stocks is characterized by longer periods. You need to have significant equity capital in order to receive a stable average annual profit. But at the same time the risks of incurring huge losses on the stock market threaten you less.
The reason for buying stocks
You can buy stocks to participate in the management of the company. But most often they are bought in order to receive income either through dividends or through the growth of the stock price. In the first case, if at the end of the year the company made a profit and the general meeting decided to distribute it among shareholders, then you would receive dividends on each of your shares. But there are no guarantees that you will receive money. If the company failed or it was decided not to distribute profits to shareholders, you would not receive dividends. In the second case, you buy stocks and expect their price to rise in the future. When you sell them, you will receive income that is the difference between the price you bought the stock for and the price you sold it for. But you also have to pay for the services of a depository or registrar, a broker’s commission and income tax. Moreover, you may, on the contrary, even lose money. For example, if your stocks get cheaper.
Exchange traded funds or ETFs
ETF (Exchange Traded Funds) is a basket of stocks collected by some attribute. When you buy an ETF share, you actually buy shares of stocks of all companies that are included in this ETF. By purchasing ETFs, you can invest in stocks and bonds of companies, real estate, commodity assets, currencies, and so on. Nowadays there are about 6000 ETFs. For example, the IVV ETF holds shares of 500 major public companies in the United States (Apple, Microsoft, Facebook, Google, etc.). The price of one share of the IVV ETF is 346$. By purchasing one share of the ETF for 346$, you become the owner of shares in all companies that are included in the fund. Over the past 5 years, this ETF has shown an average annual return of about 11%. At the same time one Amazon share costs 3176$. To build a portfolio of various securities, you will need large investments, and you also need to monitor the state of these companies and events on the stock markets. Therefore, for beginners and non-professional investors, the best choice is to invest in ETFs. The disadvantage of ETFs is that investments don’t guarantee profitability. For example, if the value of gold falls, the price of shares of an ETF linked to gold will decrease in the same proportion. If the share price goes down, the price of the ETF, which includes this share, will also collapse. But in general, fluctuations in the value of an ETF unit are usually significantly less than the share price of an individual company. After all, even if something happens to one company and the price of its shares changes significantly, this will not significantly affect the price of the entire package of shares that are included in the ETF.
Cryptocurrencies
Cryptocurrencies are digital assets that can be converted into traditional currencies such as rubles, dollars, euros, etc. Any currency has periods of decline and growth. The procedure of earning on cryptocurrency is speculative. It means you buy a cryptocurrency at a lower price and sell it at a higher price when the price rises.
The high volatility of cryptocurrencies allows you to earn quickly a lot, but no one will guarantee breakeven or even minimum profitability. If we summarize the risk factors, we can distinguish two main groups. The first one is associated with high volatility of cryptocurrencies, and the second is related to cybersecurity. You need to do research about the cryptocurrency before buying it and follow the official resources of developers. You may have to spend more than one hour to decide which of the cryptocurrencies to invest in.
Options and Futures
Options and futures are financial derivatives. By purchasing derivatives, you do not buy the assets themselves (stocks, currencies, oil or metals), but the ability to buy or sell them in the future at a fixed price. In other words, it is insurance against an unpredictable change in the value of an asset. Experienced stockists can make money on the process of buying and selling futures and options itself, but it is better for a novice investor to use these tools only to insure their financial risks.
What are futures?
Futures are contracts to sell an asset at a fixed price with a deferred payment. With the help of futures you can make the price fixed and you will be obliged to buy or sell this asset in a while – for example, in three months. During these three months, the value of the asset may rise or, conversely, fall, but the futures obliges you to make a deal at a fixed price. The bottom line is that a trader makes a deal with the expectation of an increase in the price of the asset. If at the time of closing the deal the asset price is higher than the futures price, then the trader makes a profit. If the situation is the opposite, then he loses.
What are options?
An option is a contract not for the purchase or sale itself, but for the right to buy or sell an asset at a fixed price at a certain point in the future. The right to buy is called a call option, and the right to sell is called a put option. The buyer of the option can at any time refuse the deal if it turns out to be unprofitable for him, but the seller does not. If the buyer of the option decides to use his right to buy or sell the asset at the fixed price, the seller of the option will be obliged to fulfill the contract. Therefore, only experienced exchange players who can predict the future price of assets are selling options.
In fact, for the buyer, an option is “insurance” against possible losses. If the transaction is canceled, he will simply lose the little money he paid for this “insurance” – a bonus to the option seller. Experienced investors who know how to make accurate forecasts can make profit on the sale of options. They calculate the future price of assets and offer call options at a price lower than the forecast and put options at a price higher than what they expect. Option prices are calculated by sellers based on the statistics of asset value changes, just as insurance companies calculate policy prices based on insurance claims statistics.
Remember the following rules for a novice trader or investor:
- Do not invest your last nikel and borrowed funds in the securities market.
- Keep in mind the direct relationship between risk and return. Even if stocks go up in price greatly (or you think they go up), it means that they may fall easily.
- Don’t put all your eggs in one basket. If you decide to start investing, choose several companies, preferably from different industries.
- Stay tuned. If you become a co-owner of a company, track what happens to it and the price of its securities.
- Don’t forget that practice makes perfect. You will become more and more advanced in the use of financial instruments gradually practicing.
- Learn new trends of trading constantly. For example, Artificial Intelligence can help traders/investors to manage their assets and invest rationally. MonInvAI makes forecasts for stocks and cryptocurrencies and can also be used for options and futures trading.
