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  • Trading for Beginners

    What is Financial Trading?

    Trading on financial products is a way of speculating and hoping to profit from price movements on a particular financial instrument. This could be the share price of a specific company, the price of gold or oil, the movement of a stock index or of one currency relative to another.

    Who is involved in trading?

    A private individual who trades financial products is known as a Retail Customer. But of course there are many different institutions who are involved in the markets. For instance, you have the large investment banks who act as both brokers and market makers. That is, they may hold positions themselves in specific equities and bonds, but they will also have brokers who will advise and buy and sell on behalf of their customers. These customers could be pension funds investing on behalf of their members or corporations who may need to buy or sell certain currencies in order to transact business in different countries.

    Types of Trading:

    There are three main types of trading – Spread betting, FOREX and CFDs (Contract for Differences) – and there’s a large degree of overlap between them.

    A – Spread betting:
    In many ways spread betting is the most straightforward in that you have a choice over which currency you deal in and it’s very easy to calculate profits and losses. Spread betting also has certain tax advantages, at least under current UK legislation. But this also means that it’s not possible to hold a spread betting account from many countries. For this reason we cover spread betting in detail from here

    B – Contract for Differences (CFD):

    A CFD is an agreement between two parties to exchange the difference between the opening and closing price of a contract. This can be the price movement of an individual share, a stock index, commodity or currency pair. In fact, it’s important to note that currency trading can take place through spread betting (see @), CFDs or through a dedicated FOREX account. In all cases, these trading methods allow parties in the agreement to speculate on falling as well as rising prices. Also, all are margined products and employ leverage. This means that you can control a large position in the underlying financial instrument with a relatively small deposit requirement.

    C – Forex:
    FX, FOREX or currency trading refers to speculating on how a particular currency will move relative to another. FX trading can take place using a designated FX platform, or can be done via spread bets (@) or CFDs. If you are new to trading then FX can be slightly confusing initially. After all, it’s easy to understand price fluctuations in a share price of a corporation, or in a barrel of oil or an ounce of gold. But with FX pairs, if one part of the pair is going up in value, then the other half must be falling. For instance, if we consider the British pound against the US dollar (GBPUSD), what does it mean if it moves from 1.3800 to 1.4000? In this example sterling is rising in value. Whereas £1 initially bought you $1.38, it now buys you $1.40. So the pound is worth more while the US dollar will buy you less.

    Buying and Selling/Going long or short:

    When you trade you never actually own the product that you buy. In the same way, when you sell you’re simply speculating that the price of the underlying financial instrument will fall in value. Then, if so, you hope to buy it back and close out your position at a lower value. The difference between your selling and buying price, multiplied by your trade size, is your profit, or loss. As mentioned earlier, you only have to put up a small percentage of the overall value of the contract to control a large position in it. The money you put up is called “margin” and this means you are using leverage when you trade, which we explain later on.

    Going Long / Short:

    “Buying” is also called “going long” while “selling” is called going short. It’s just as easy to speculate on a market falling in value as rising This can be really useful. For instance, you may have a portfolio of stocks and be worried that the share prices of global corporations are overvalued and ready for a pull-back. Now, you could simply do nothing and hope that you are wrong. You could also sell all your stock holdings and realise any profits. The problem with this is the cost in terms of stamp duty, commissions and the possibility of realising a taxable capital gain. The alternative is to take out a full or partial hedge by shorting a stock index. This would give you some protection in a downturn, yet preserve your portfolio and save you excessive dealing costs. This hedge could also be carried out cost-effectively. Dealing spreads are competitive, there’s no stamp duty on CFDs or spread bets and you can carry out the short position using margin.

    What the Spread Means:

    The spread is the difference between your selling and buying price. Spreads can be fixed or variable. Fixed means that the size of the spread is constant, whereas variable spreads change, as a function of market activity. Sometimes this means that the variable spread is narrower than may be available with fixed spreads, but this isn’t always the case. Variable spreads tend to be tightest when trading volumes and market liquidity is high. In quieter times, there’s a tendency for spreads to widen. A fixed spread gives you the certainty that the cost is the same when close your trade as when you opened it.

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