What is Trading?

Trading vs. Investing  |  ASX Companies  |  ASX Company Dividends  |  ASX Products  |  ASX Product Codes  |  Indices / Sectors

In simple terms, trading is the process whereby we regularly buy financial products, primarily in a market (more officially referred to as an exchange), and then sell them later for a higher price. This simple concept makes a lot of sense and is probably the main reason why people generally think that trading is easy money.

The financial product that we buy and sell may be shares in a company, a futures contract related to a commodity, or even a foreign currency, for example.  Many people don’t know that many markets offer the opportunity to take advantage of and financially benefit from a falling price as well. This is often referred to as trading ‘short’, as opposed to the aforementioned and more commonly known ‘long’ trading.

Furthermore, trading can take place over a wide expanse of time frames.  Some people will trade analysing short term movements over minutes or hours, and others will trade using analysis over weeks and months.   There is no right or wrong way – it ultimately depends on what suits you best.

Trading can be a very exciting and worthwhile endeavour and there are several attractions for most people (not including ‘making money’ which is obvious).

Some of the advantages of trading include:

  • Self employed – you are your own boss
  • Geographical freedom – technological advances are making this easier every day
  • Minimal capital outlay – compare this with purchasing a franchise or establishing a new retail store in your nearest shopping complex.
  • Unlimited potential for profit – financial freedom is what most traders aim for
  • Flexibility with time – you choose when you trade and when you don’t
  • Almost anyone can do it – if you are old enough, you can open a trading account and begin

There are of course some disadvantages which include:

  • No guaranteed success – many people don’t make money trading
  • Can be stressful and emotional – when you are ‘playing’ with your own money, this is almost inevitable
  • Solitary existence – trading can be a very lonely profession
  • Takes time – like many endeavours, consistently profitable trading takes time. I list this as a disadvantage because I believe many newcomers don’t recognise this, nor do they fully appreciate what is required to develop the skills and attributes for successful trading.

What are markets?

Markets to facilitate trading are established in most developed countries and have existed for many years. Furthermore, markets are now vital parts of the corporate world in that country and therefore are highly likely to continue to operate for many years to come.

Markets are a vital part of the corporate world and exist to serve two general purposes. First, they allow for the bringing of buyers and sellers of capital together in an efficient manner. It therefore channels capital resources to those who will make the best use of them.

This means that we as an individual can invest some of our own money into a company along with many others. We would do this by purchasing stock (or shares) in the company.

Stock is an equity security in that it represents the basic unit of ownership in a company. The total of all shares in a company represents its equity capital. Equity capital is also often referred to as ‘risk capital’ as the owners have no guarantee of a return on their investment. When you buy stock, you become a part owner of the company and therefore share in its profits and losses.

One benefit of owning stock is receiving dividends and the other (of more interest to traders) is from the capital gain you can enjoy. Stock prices fluctuate on a daily basis according to the supply and demand for that stock and you are able to benefit from a rising price and selling the stock for higher than what you purchased. Net result is a profit.

Having access to such an efficient process of capital resource allocation, we should ideally earn the best rate of return when investing in those companies listed on the stock market.

The second purpose of markets (moreso for derivative and foreign exchange / currency markets) is for the management of risk. It allows for large companies who have a risk exposure in the future to hedge and protect themselves against an adverse move in the price of something. These markets are very actively traded and includes trading between large banks, central banks, governments, and other financial markets and institutions.

Derivatives include products like options and futures, and foreign exchange / currency markets facilitate the trading of just that – cash. You buy an amount of money in one currency with the equivalent amount in another currency. Currency markets, aka ‘foreign exchange’, ‘forex’ and ‘FX’ are the largest in the world, ie. they consistently have the most money traded every day – now over $4 trillion US dollars per day.

Individual traders will also trade these large markets and are known as speculators. That’s people like you and I.

How Can I Help You?

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