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Types of Financial Markets that Traders Should Know

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The financial market is a marketplace where financial securities are traded on both a national and global level. Traders buy and sell those securities to gain potential profits while trying to keep their risks limited. Many traders tend to focus on one financial market, for example, trading stocks or CFDs, but it is important to have an all-round overview of all the financial markets, because they can impact each other. This article reviews the most important financial markets and explains their global role.

Types of Financial Markets that Traders Should Know

Financial Markets Explained

What are financial markets?

The financial market is, at its core, not much different to other markets, where goods and produce are bought and sold. But rather than the exchange of vegetables, clothing, or computers for a local or national currency, the financial markets are focused on buying, selling, and holding of financial securities, products and instruments. The financial markets have expanded exponentially over the past few decades, and now offer many types of financial instruments.

Here are the most important ones:

  • Forex - (Also known as: the Foreign Exchange Market or FX)
  • Capital markets - such as stocks and bonds markets
  • Derivatives markets - such as CFDs (Also known as: Contracts for Differences)
  • Commodities markets - which include Gold, Silver and Oil
  • Money markets - such as short-term debt
  • Cryptocurrency markets - which include Bitcoin and Altcoins
  • Mortgage markets - which offer long-term loans
  • Insurance markets - which transfer risk for a premium

Admiral Markets MetaTrader 5 Supreme Edition

Source: Admiral Markets MT5 with MT5SE Add-on GBP/USD Daily chart (Data range: between 24 April 2017 to 28 September 2018) - performed on 28 September 2018 at 7:00 AM GMT

Some of these financial markets are by their own nature more long-term focused, short-term oriented, or a mixture of both. The mortgage market for instance, is where many long-term loans take place, whereas money markets are focused on the short-term. Forex, stock, CFDs and commodities can be traded both short and long-term. Professional traders can decide to engage in investments or trading, depending on their own approach and trading style.

The financial markets serve an important purpose for the economy and offer six basic functions:

  1. Price determination
  2. Liquidity
  3. Efficiency (costs like transaction costs)
  4. Traditional borrowing and lending
  5. Information about flow of funds
  6. Risk sharing

Financial institutions help to facilitate the flow and movement of funds within the global markets and the overall financial system. These institutions include commercial banks, investment banks, central banks, insurance firms, brokers, and even non-banking financial institutions (such as credit unions).

Forex 101

Financial Markets Today

Generally speaking, the financial markets appear to be the engine of international trade and the overall global economy for the past 100 years. Especially the last 25 years, wherein the financial markets are becoming even more complex, sophisticated, and important. At the start of the 21st century, the global financial markets became more dynamic and were changing quickly. Nowadays there are less exchange controls, capital controls, more global financial transactions, and more payment systems in general.

There is also rapid movement in terms of international capital flows, the development of new financial instruments (such as cryptos), and new digital technologies. Overall, this is leading societies to more open, advanced financial markets and methods. Although the above trends are valid for the financial markets in general, each financial market has its own separate trends. We will discuss a few trends for the Forex and stock markets.

Forex Market

The Forex market has become very popular over the past few decades, and has seen enormous growth of volume in the last 30 years. Here is the trend explored in greater detail:

  • 1977 - $5 billion
  • 1987 - $600 billion
  • 1992 - $1 trillion
  • 2001 - $1.5 trillion
  • 2007 - $3 trillion
  • 2010 - $4 trillion
  • 2013 - $5.3 trillion
  • 2017 - $5.5 trillion

As you can see, the Forex volume has increased by a factor of 1000 within 40 years. It has also increased by 267% between 2001 and 2017, and by 40% between 2010 and 2017. These impressive growth figures show just how important the foreign exchange market has become.

Stock Market

Another trend could be found in the global stock markets, where the US stock markets have arguably become much more important compared with other parts of the world. The US stock market was a major winner in the 20th century, according to the book the "Triumph of the Optimists" (2002) written by Elroy Dimson, Paul Marsh, and Mike Staunton. Their research indicates that three important changes have occured within the last 100 years:

  • The US has achieved market dominance
  • The exchanges were consolidated
  • Secular (market activities occurring over the long term) sector rotation occurred

Here are some graphs that display information pertaining to the world's stock markets in both 1900 and 2000:

stock markets 1900

Source: Investopedia - ''Triumph of the Optimists - Dimson, et al.''

These graphs show how the US stock markets grew from 22% in 1900 to 47% in 2000. Their share more then doubled, and almost reached 50%. Another country that grew in numbers besides the US was Japan, with an increase of share from 4% to 13%. Most other regions lost market share. The UK dropped from 12% to 8%, and the Euroland went from 25% to 13%. Some countries disappeared from the list, whereas others entered the list for the very first time. Canada was not on the list in 1900, but had a 2% share in 2000. Other countries during 1900 managed to keep 7%, whereas 'New Markets' counted for 6% in 2000.

stock markets 2000

Source: Investopedia - ''Triumph of the Optimists - Dimson, et al.''

Business sectors changed substantially between 1900 and 2000. Sectors that were very strong in 1900, such as railroads, lost substantial market share one century later. Railroads went from 62.8% in 1900 to 0.2% in 2000. For instance, iron, coal and steel went from 5.2% to 0.3%. Other industries rose, such as banks and finance, and retailers. Some sectors that were large in 2000 did not have any market share in 1900. Information technology jumped from 0 to 23.1% in 2000. Pharmaceuticals, insurance, and diversified industries also saw large growth in their shares.

Of course, the trends of the past century do not have to be the trends of this century. Luckily traders do not need to know how the future will look like 100 years from now. They can choose to trade shorter time frames such as one trading daily, weekly, or monthly. Ultimately, it is easier to understand what the financial markets might be doing in the short-term rather than in the long-term, especially when analysing an entire century

U.S. Sector Weightings - 1900

Sectors

1900

2000

Difference

Railroads

62.8%

0.2%

-62.6%

Banks and Finance

6.7%

12.9%

6.2%

Mining

0.0%

0.0%

0.0%

Textiles

0.7%

0.2%

-0.5%

Iron, Coal, Steel

5.2%

0.3%

-4.9%

Breweries and Distilleries

0.3%

0.4%

0.1%

Utilities

4.8%

3.8%

-1.0%

Telegraph and Telephone

3.9%

5.6%

1.7%

Insurance

0.0%

4.9%

4.9%

Other Transport

3.7%

0.5%

-3.2%

Chemicals

0.5%

1.2%

0.7%

Food Manufacturing

2.5%

1.2%

-1.3%

Retailers

01.%

5.6%

5.5%

Tobacco

4.0%

0.8%

-3.2%

Sectors Small In 1900

4.8%

62.4%

57.6%

Total

100.0%

100.0%


Source: Investopedia - ''Triumph of the Optimists - Dimson, et al.''


U.S. Sector Weightings - 2000

Sectors

2000

1900

Difference

Information Technology

23.1%

0.0%

23.1%

Banks and Finance

12.9%

6.7%

6.2%

Pharmaceuticals

11.2%

0.0%

6.2%

Telecommunications

5.6%

3.9%

1.7%

Retailers

5.6%

0.1%

5.5%

Oil and Gas

5.2%

0.0%

5.2%

Diversified Industrials

5.1%

0.0%

5.1%

Insurance

4.9%

0.0%

4.9%

Utilities

3.8%

4.8%

-1.0%

Media and Photography

2.5%

0.0%

2.5%

Breweries and Distilleries

0.4%

0.3%

0.1%

Mining

0.0%

0.0%

0.0%

Sectors Small In 2000

19.7%

84.2%

-64.5%

Total

100.0%

100.0%


Similar sectors in base year of 2000 and 1900

Source: Investopedia - ''Triumph of the Optimists - Dimson, et al.''


Overview Of The Financial Markets

This part will provide an overview of the different types of financial markets that were mentioned earlier.

Forex Market

As mentioned before, the growth of the Forex market and its volume has been impressive in the last 40 years - from $5 billion in 1977 to more than $5 trillion in 2017. There are a couple of key factors that are contributing to this trend:

  • Advanced computers
  • More price volatility
  • Better access to financial markets via brokers
  • More trading tools and access to information

Forex is a type of market that is popular with traders who are looking for short and medium term trading opportunities.

Derivatives Markets

Derivatives are securities that are connected to an underlying asset and are sometimes used as a hedge against price changes. Options, futures and CFDs are all examples of derivatives. Speculators can use these instruments to hedge against risk, or to take risk in order to make potential financial gain.

Commodities Markets

The commodity market comprises of hard commodities such as gold, oil, and soft commodities such as agricultural and livestock products. Investors and traders can take part indirectly in a commodity by purchasing stocks or directly by buying an option, future or a CFD.

Capital Markets

Capital markets include the stock and bond markets (both private and public sector bonds). There is a primary market, where companies and governments issue new securities, and a secondary market, where previously issued stocks and bonds are traded.

Insurance and Mortgage Markets

Mortgage markets revolve around long-term loans that are provided for buying property. These loans can be traded on secondary mortgage markets. Insurance markets involve the insurer and the insured, where the risk is transferred for a premium. Insurance companies have substantial cash reserves which they invest in stocks, bonds, and derivatives markets.

Money Markets

Money markets are focused on very short-term debt, and involve local banks and central banks. Banks loan to each other for short-term liquidity purposes. The central bank often acts as the lender of last resort.

Cryptocurrency Markets

Although it is a new market, Bitcoin and other Altcoins captured the headlines at the end of 2017 when strong price volatility caused a surge in prices. The blockchain technology and mining system caused an increased interest in the cryptocurrency market. How this market will continue, how it will shape the financial markets in general, and whether it can create more value for consumers and the financial system or not is still something that will be determined in the next few years.

The Best Platform For Forex And CFD Trading

The best trading platform for Forex and CFD trading is arguably the MetaTrader 4 Supreme Edition. Traders can use scalping strategies on a wide range of other financial instruments, including Forex, CFDs, CFDs on commodities, and stock indices. The MetaTrader platform offers a charting platform that is not only easy to use, but also simple to navigate. If you would like to learn more about trading, we highly recommend checking out our articles & tutorials. If you would like to learn more about some of the topics we covered today in greater detail such as, trading styles and time frames, we would recommend reading the following articles:

Pros and Cons of Scalping vs Day Trading vs Swing Trading

How Often Should Traders Day Trade?

Learn Why Multiple Time Frame Analysis Is Key for Trading

Download MetaTrader 4 Supreme Edition

This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.

Risk Warning

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 83% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.