MARKETS FOR TRADING
Almost anything with a liquid price, from shares in a new company to soybean meal, from raw aluminium to Patagonian currency (whatever that is!), is probably trade-able somewhere in the world, through some vehicle, on some exchange. So, with such a bewildering array of instruments on offer, how do you set about deciding exactly what to trade? Let’s start by taking a look at some of the different types of instruments on offer:
Stocks and Shares
Because they are sometimes insufficiently liquid, a large proportion of individual stocks are not ideally suited to short term trading strategies. One or two of the day-trading setups we cover (such as the opening gap) could be played in the very heavy stocks, but with the super-liquid indices sitting there, why bother? Individual stocks really come into their own when used as part of longer-term investment strategies such as the Dual MA setup described in the Swing Trading section.
Stocks and shares are a method of equity participation – when you buy shares in a company’s capital stock, you attain ownership of a fraction of that business. Typically, you will receive a certificate of this ownership. Shares are simply the units into which a company’s total stock is divided. There are different classes of shares, each of which have specific rules, privileges, and values.
Unlike shares, which are an equity security, the various forms of bond are debt securities. They are issued by institutions in order to raise equity – often governments who wish to finance current expenditure. Essentially they are a loan contract: the issuer of the bond is a borrower (debtor), and the holder is the lender (creditor). The date at which the loan must be settled (along with any interest) is when the bond is said to ‘mature’. With ‘perpetuity’ or ‘Consol Bonds’ there is no fixed maturity date.
Bonds are typically a vehicle for very long term investment (usually between 10 and 30 years), rather than something you’re likely to actively trade. However, movements in the bond markets provide important fundamental information when considering directions in the stock markets (we’ll explore this in a much later setup).
An index is simply a group of stocks, and its price is determined by the total price of its constituent stocks. Any change in an index represents the net change in the price of its constituent stocks. The FTSE100, for example, contains one hundred of the UK’s largest stocks, and if the price of all of these stocks rises on a given day, then the value of the FTSE index will rise also. If most of the stocks rise but a small group, the retail sector for example, declines, then the value of the index would most likely still rise – just one sector alone would have to decline very significantly in order to ‘outweigh’ and drag down the whole index.
Many of the strategies we will cover are intended for trading the indices, in particular the FTSE100, the DOW30 (or Dow Jones Industrial Average), and the S&P500 (or ‘Standard and Poors’). Unlike its constituent stocks, which you can physically buy and own, an index doesn’t really exist in any literal sense (it’s just the total price of a group of stocks), so there is no way that you can buy or own ‘the FTSE’ as such – you will need to trade one of a number of derivative products whose price is determined by that of the index – more on this shortly . . .
You might well expect that the price of a commodity such as lumber or corn would be dictated almost entirely by fundamental factors such as the weather or consumer demand. Commodities are, after all, very real-world things that people need, and are subject to all the changeability of the real world – droughts, plagues, collapsed mines, and political takeovers. You’ll be surprised to learn then, that commodities often trend beautifully, and can be traded according to specific strategies with relative ease. You don’t need to know anything about the state of coffee farming in Kenya to trade coffee! If something is truly capable of moving a market then the first place that this will be reflected is in price, and someone who knows nothing whatsoever about coffee will be able to relate to these movements on a price chart and begin to draw some conclusions.
Nevertheless, this doesn’t stop lots of people trading commodities of fundamental data alone, and though such speculators are often very well informed, they frequently miss time their entries into the markets, providing easy pickings for the disciplined technical trader.
The currency or ‘forex’ markets are not something that we will cover in this course beyond a brief introduction here. Why? Forex can be very difficult to trade, especially as a beginner. Learning to trade with consistently profitable results is never a breeze, so why not give yourself a break and steer clear of the difficulties of forex until you have gained some experience in an easier market?
Here are some of the reasons (some of which may sound rather cynical) why the forex markets are not a good place for you when starting out:
All forex pairs (that’s the value of one currency against another – the dollar against the yen, for example) are traded with spreads rather than commissions. In the first instance this is the bid/ask spread, and it is what the banks and institutions pay – they have no ‘brokerage’ fee to pay as forex is an interbank market, which means that the banks are the market makers. If you want to participate in this market you will have to do so through a broker, who will have been quoted a wider spread by the bank, and this he will pass along to you. The broker probably won’t charge you any commission, but instead he will widen the spread even further to ensure a profit for himself, so by the time that you’re quoted the spread it may have been inflated from something negligible to somewhere in the region of 5 pips (a ‘pip’ is an abbreviation of ‘price interest point’, and is the minimum permissible movement in a currency pair, rather like ‘ticks’ in other markets).
You will need to factor in spreads when you place stops and targets. If you buy at the top of a five point spread, then to exit this position you must sell at the bottom of the spread, which is already five points away from where you have entered at the top. If you have a stop placed ten points from your entry at the top of the spread then this stop is only actually five points from where the bottom of the spread is – just a five point move against you will result in you being stopped out for a ten point loss. If none of this makes any sense to you yet, then that’s another good reason not to trade forex!
The interbank market is de-centralised (it doesn’t trade anywhere in particular on an exchange) and it is not regulated – this means that those with the real muscle in the big investment banks can do pretty much whatever they please. Like ferreting out your stops to create liquidity for their own orders (they can see exactly where they are because the stops are on their order books). De-centralisation also means that there is no authoritative data source, and that there are no market internals such as volume to confirm your trading decisions. Why would you choose to trade a market where you don’t have all this valuable information at you fingertips?
For some reason there is currently a great deal of romance attached to forex trading, and millions of amateurs hand trillions of pounds over to the markets each year. Take a quick glance around the trading forums online and you will see how popular the Forex markets are with amateur traders, and also how many of them are frustrated with their inability to turn a profit. Try not to become one of them!