Get to Know the Eight Financial Markets
When most people think of financial markets, they think of the stock market or forex. While it’s true these are the largest investment markets, they’re far from the only ones. In fact, there are eight unique financial markets – each with different opportunities. Whether you’re a new investor or looking to diversify, it’s worth understanding investment market options.
Here’s a breakdown of each financial market, what types of securities each trades and some of the activity common to them.
A Basic Breakdown of All Financial Markets
1. Stock Markets
Stock markets play host to companies who sell shares of their business to investors. There are stock exchanges all over the world, including the New York Stock Exchange (NYSE), the Nasdaq, the London Stock Exchange (LON) and the Japan Stock Exchange (JPX). Traders and investors buy shares in companies or indices and seek to sell them at a higher value. Buying and selling happens through brokers. Moreover, stock markets have many regulations, rules and guidelines for both the companies and investors.
Stock markets play a big role in the economic stability of a country. Not only do public companies list shares on these markets, but also many different avenues of wealth tie into them. For example, many retirement funds (401k, IRA) are vested in stock markets.
2. Bond Markets
Bond markets involve buying securities at preestablished interest rates. These markets are also called the credit market or the debt market. Investments have a set vesting period, making them a surety agreement between bond buyers and issuers. You might invest in a 10-year bond at a 1.69% interest rate, for example. Bonds are very stable, low-risk investments. As such, they typically have lower yields than other investments, like stocks.
The bond market includes bonds issued by companies, municipalities, states, the federal government, international sovereignties and more. Bonds come with different terms and rates depending on the issuer.
3. OTC Markets
Over-the-counter (OTC) markets are a form of direct exchange. OTC transactions don’t require brokers, and the markets themselves are decentralized. OTC markets can carry higher risk. This is because they’re unregulated and the securities traded within them are more volatile. Typically, OTC stock markets for “pink sheets” refers to buying and selling stocks that don’t meet minimum listing requirements on major exchanges.
OTC markets can also refer to derivatives. Forward contracts, for example, trade OTC. This is because the trading parties negotiate the terms of the contract. Other OTC assets include swaps and exotic options.
4. Money Markets
Like bond markets, money markets are highly stable and offer lower returns. Money markets represent high-liquidity assets that appreciate within a year. Money markets involve everything from retail investment to CDs and treasury bills. The short time frame of these investments makes them more appealing to investors who want a relatively guaranteed return and are willing to take low return on low risk.
Money markets are also liquid. Unlike bonds, investors have the ability to take money out of these markets in an emergency, albeit for a smaller return. They’re a step up from high-yield savings accounts, but a step down from other vested accounts.
5. Forex Markets
Forex markets are where currency trade occurs. Currency trades occur in pairs, where buyers and sellers seek to capitalize on exchange rates. Forex is the most liquid of all stock markets and sees the highest daily trading volume – in the trillions. It’s technically an OTC market, which means it’s decentralized and self-regulated. Retail investors also have more power in the forex market since it operates with 50:1 leverage.
Forex markets offer a more limited scope of tradable securities with 28 major currency pairs. However, trades occur 24 hours a day, five days a week. There’s ample opportunity for traders to find profit. And constant volatility means prices are always in flux.
6. Cryptocurrency Markets
Crypto markets are emerging fast. They are gaining immense popularity with many institutional investors allocating capital in cryptocurrencies. The largest currencies in these markets are Bitcoin and Ethereum. The assets traded are decentralized. However, the exchanges are centralized.
There are decentralized exchanges, but they’re few and far between. Crypto exchanges serve the role of exchanging fiat currency for cryptocurrency.
As crypto becomes more mainstream, the market is likely to evolve. There are already derivatives springing up, such as crypto futures and options. Generally, cryptocurrencies aren’t considered stable. This is because, unlike fiat currency – which has value pegged to another currency – crypto is completely decentralized.
7. Derivatives Market
Derivatives markets focus on trading the actions of an underlying asset. Derivatives investors don’t own the underlying asset. Instead, they bet on the value of the asset and its movement. The most common derivatives include options, futures and credit swaps. Investors bet on the movement of these assets as a way to hedge against the risk inherent in other investments.
It’s increasingly common for retail investors to rely on derivatives as part of their trading strategy. For example, they might buy a put option on a stock to hedge against sudden downturn in that security’s price. In fact, derivatives can play both sides of an investment.
8. Commodity Markets
Commodity markets focus on the value of staple goods. The largest asset classes on commodity markets include agriculture products, petroleum products, precious metals, energy products and soft commodities. While it’s possible to invest in commodities directly, much of the commodity market is in derivatives. Investment directly in commodities happens through the spot market – the spot price represents the going price per unit.
Commodity markets operate in both OTC and exchange capacities. Derivatives are naturally OTC. Two of the world’s largest commodities exchanges include the Chicago Mercantile Exchange (CME) and the Intercontinental Exchange (ICE).
Each Financial Market Offers Opportunity
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All eight financial markets offer great opportunities to investors and traders who understand how they work. Before opening any positions, take the time to learn the basics about the securities traded in each market as well as trading rules. From stocks and bonds to derivatives and commodities, the opportunities for investment abound.