Where is all the money going? Online traders have many investment options to choose from. One way to learn where to invest is to follow the money flows.
In the forex market—a market with a daily turnover of $5 billion, according to regulated broker TradeFW.com—money moves fast.
One recent day the USD/JPY shot up and down on various economic reports. But then the Yen fought back. As equity market volatility approached a 10-year high ahead of Thanksgiving Day, money was flowing out of US stocks. Opportunistic investors reacted to the US stock market volatility by moving money into the Japanese Yen.
Investment markets are so tightly interconnected that price swings in the US Dollar or Japanese Yen can affect many other asset classes. These price swings reflect changes in investor sentiment. Fortunately, volatility can be tamed. Price fluctuations not only increase the risks of losses but also the opportunities to realize gains.
With a sensible risk management plan and deft choice of investment instruments, you can smooth out price volatility and protect your investments from downside risk.
These basic investment instruments and strategies not only allow you to take a long or short position on a price direction of an underlying asset but also hedge price changes and protect your investment.
Top Financial Trading Options
A contract for differences (CFD) is a trade made directly between the buyer and seller whose terms are based on the price movement of an underlying asset (e.g., a stock, bond, foreign currency). Neither party is required to take ownership of the underlying asset. The seller agrees to pay the buyer the difference in the price of the underlying asset from the time of contract entry to a predetermined contact end date. Large institutional traders trade CFDs directly among themselves while most individual investors do online CFD trading with a broker.
Forex trading is the buying and selling of currencies. The top 10 currencies traded are the United States Dollar, Euro, Japanese Yen, Pound Sterling, Australian Dollar, Swiss Franc, Canadian Dollar, Hong Kong Dollar, Swedish Krona and New Zealand Dollar.
The two types of traders active in the forex market are speculators and hedgers. Speculators, who do not have any exposure to the underlying currencies, trade on price direction in the spot market. Commercial hedgers buy futures and forward contracts to cover their exposure to changes in currency prices as a result of trade in global goods and services. Futures and forwards are commonly used in commodity trading (e.g., oil, agricultural products).
Spread betting is a bet on the price movement of a security using leverage. The trader bets the price of a security will trade below the bid or above the offer price quoted by a broker. The trader multiplies his potential gains and losses by trading on margin—borrowed collateral to cover some or all his exposure to price risk.
Forwards and Futures
Forwards and futures are derivatives contracts stipulating the buying or selling of assets at a future date. Futures are contracts with standardized terms traded on an exchange whereas forwards are directly traded over the counter between the buyer and the seller. The terms of forward contracts are flexible and negotiated between the two parties.
While forward contracts allow products to be more precisely tailored to cover risk exposures, they have higher counterparty risk. On a futures exchange, the clearinghouse acts as the counterparty and the investor is required to maintain a margin account to cover potential losses.
Forward contracts are primarily used by hedgers who settle the contract on the expiration date by physical delivery or cash. Speculators use futures to cover their exposure to bets on price direction, and typically close the position before expiration.
An option is a right but not an obligation to buy (a call option) or sell (a put option) a security at a predetermined price at a future date. The buyer profits if the option price increases while a seller profits if it decreases. Most major financial markets regulate options trading and forex brokers.
Binary options are an exotic option with an all-or-nothing payoff—a 50/50 gamble on market direction. They can be traded on any underlying security. The most commonly traded option is an up/down option. The trader bets whether the price will be above or below a chosen strike price at a predetermined time. If the price moves in the opposite direction of the bet, the trader loses the full amount pledged (out of the money). If the price moves in the direction of the trade (in the money). Binary options trading can only be offered by a regulated forex broker in many countries. Regulators have shut down many unauthorized binary options brokers.
Spot trading is the buying and selling of securities for immediate settlement. About 40 percent of forex trades are FX spot trades. Most trades on forex online trading platforms take place in the spot market.
Your trading and investment objectives and risk profile will determine the best investment options for you.
If you are a young, high risk taker, you may choose to gamble with binary options. Even the high roller should be careful, though, and set strict risk limits. Also known as knock-out options, your odds of winning are the same as rolling the dice.
An astute conservative investor may choose to use low cost options to trade the forex markets. Instead of buying currencies at face value, you are only required to pay the options fees and, if you lose, the difference between the entry and strike price.
The best traders set and respect trading limits. Online trading makes it easy for gut instinct and human impulse to take over with a click of a mouse. Automating your trading limits with a trading bot will ensure emotions do not run your trading program.