As technology increases and trading innovation continues, the world is seeing an expansion in the types of trading instruments that can be used. Even seemingly separate markets are attempting to steal each other's market share. For example, a person no longer needs to buy gold physically or even from a futures contract, they can simply buy an exchange traded fund (ETF) to participate in the movement of gold prices. Considering that similar scenarios are possible with currencies, commodities, stocks and other investments, traders can fine tune how they trade and tailor it more to their individual circumstances.
TUTORIAL: Trading Systems
Markets, Markets, Markets
Depending on education and experience, a person may not even be totally aware of the investments or trading vehicles that are accessible with a click of the mouse. Even while avoiding abstract and illiquid markets, traders can find trades within many different markets:
Stock Market: This well known market simply involves buying/shorting shares of a company.
ETF Market: Funds representing all sorts of sectors, industries, currencies and commodities. Trading similar to stocks, these funds can be bought and sold rapidly or held long term.
Forex Market: The largest market in the world. The forex market facilitates the exchange of one currency for another currency. Currencies are always traded in pairs, with many potential combinations available, but only some of which are very liquid.
Options Market: A market which allows participants to undertake positions in the derivative of an asset. Therefore, the option is not ownership of an underlying asset (though rights and obligations exist), but the option price (along with other inputs) fluctuates with the value (or lack of) that the underlying asset is providing.
Contract for Difference (CFD): A hybrid of the stock, forex and options market that allows participants to place trades in a derivative product based on an underlying asset. Generally the CFD does not have an expiry date, premium or commission (see broker's terms and conditions), but does require the participant generally pay a larger bid/ask spread than what would be seen in the actual physical market for a product. (To learn more about CFDs, see Instead of Stocks, Trade A CFD.)
While there are other markets, these markets are all now easily accessible from home to just about anyone with an internet connection. Each market offers different advantages and disadvantages. Because of this many traders may decide to trade only one market because they feel it suits one aspect of their life or they lack knowledge of available markets. This could mean that traders are not taking advantage of the correct market given their trading style.
Which Markets to Trade?
The style of trading employed, financial resources, location and what time of day a person trades (or wants to trade), can all play a role in which markets will be best suited to the individual. Since some of these markets may not be familiar we will look at two common trader groups and how they could implement the use of other markets to improve their trading. It is important to be aware of such alternatives, as they may provide for some fine tuning which can result in better results over the long run.
Alternative Markets For Day Traders
Since 2000 there has been a steady increase in the amount of turnover in the foreign exchange markets. This has meant an increase in the number of day traders opening accounts with forex and CFD brokers, which have also increased in number. The main lure is that minimal investment is required. Accounts can often be opened for as little as $100-$1000 and will allow individuals to day trade global currencies, indexes and commodities. With the forex market the trader is actually exchanging one currency for another, possibly in an account denominated in yet another currency. It seems nice – low barriers to entry, generally no commission (but a spread is paid), high leverage (high risk/high reward) and free trading tools such as charts and research. But there are alternatives if one wants to trade forex or CFDs, which can encompass just about every other market. (Check out Day Trading Strategies for beginners to learn about some common strategies.)
Exchange traded funds now allow traders to partake in the currency moves by making trades on the stock exchange. While opening a day trading stock/ETF account will require more capital, there are advantages in that ETFs themselves can be leveraged or unleveraged. This means someone who wants to take on additional risk/reward for each incremental price movement can do so by buying a "3X bull" ETF for example. Also, with an ETF, a trader is not required to pay the spread. Instead, they can sit on the bid or offer providing liquidity and thus collecting ECN rebates (offsetting commissions, or providing additional profit). This is very advantageous in currency pairs with limited movement, or when the trader wishes to implement a scalping strategy.
ETFs also allow a trader to partake in other markets such as the movement of oil gold, silver or stock indexes; traders can move out of the CFD market and begin trading ETFs as well, providing them with a greater range of products. Depending on trading style, using ETFs, CFDs and the forex market may be wise. Different instruments can be used to hedge or take advantage of disconnects in price such as a currency pair moving without the corresponding ETF moving (or vice versa).
Alternative Markets For Long Term Investors
Commodities often attract long term investors, yet they may be unfamiliar with futures markets and so they have not participated directly in the movements of commodities such as gold, silver or platinum. Also, it is unlikely they have different currency exposure. And while they may have considered options trading, the time-framed nature of the instrument does not appeal to their trading plan.
Here is another opportunity where understanding different markets can open new doors even for conservative investors who make few trades. After learning about the different markets, the forex market can be used to gain currency exposure. ETFs can also be used to gain currency exposure, as well as participate in the price movements of gold, oil, silver or even other global economies. CFDs can be used by long term traders since the bid/ask spread is minimal over the time frame and they provide some of the benefits of options, but without the expiry date. For instance, large blue chip stocks are often available via CFDs. The stock is not actually owned, which allows for the participation in price movements with less capital in use (because high leverage can be used if desired), but the CFD does not provide voting rights or any of the perks associated with ownership of a piece of that company. When trading any instrument it is important to be aware of taxes and how the instruments fit into overall objectives, including retirement.
Each instrument may be treated slightly different; therefore it is wise to seek out the advice of a professional.
It is important to be aware that alternatives are out there. This does not mean every alternative will be good for every individual, but using a combination of markets or fine tuning how we interact with those markets can have an impact on results. For some individuals this may mean they need to switch markets as their success is unlikely if they continue to do what they are doing. On the other hand, incorporating other markets may provide benefits like small changes in costs, capital outlays and risks that can have large effects over the long run. Becoming familiar with all the markets available will allow for more opportunities and potentially increased profits or reduced costs. (For related reading, take a look at 5 Equity Derivatives And How They Work.)