We gain access to financial markets using financial products and instruments.
You may already be familiar with some of them. Savings, government bonds, mutual funds, individual shares and exchange-traded funds (ETFs) are all examples of financial products.
Financial products can be grouped into two main categories: complex and non-complex.
Non-complex financial products are better suited to beginner traders who don’t yet have much specialist knowledge. For example, buying and selling shares is a straightforward practice that most people can understand, so it’s considered non-complex.
You can also access the markets using complex financial products. These let you benefit from the rising or falling prices of an asset without having to own it. They’re considered complex because they aren’t likely to be understood by the average market participant, like leveraged derivatives.
For example, spread bets and contracts for difference (CFDs) are complex products. They’re called derivative instruments because the value we unlock when using them is derived from the price movement of the underlying asset. And unlike the more traditional solutions like buying shares in a company, derivatives trading requires a smaller initial investment for full exposure to the market due to leverage.
Did you know?
Derivatives trading involves speculating on the price movement of financial assets using instruments such as spread bets and CFDs. These assets include company shares, currency pairs, indices, commodities and cryptocurrencies.
You trade derivatives by ‘going long’ when you think the value of an asset will rise or ‘going short’ when you think it will fall. Any profits or losses you make will depend on which way the market moves and by how much.
Derivative products can be incredibly powerful wealth-building tools. They can amplify your returns and it generally takes less time to make a profit. However, it’s important to be aware of the risks involved in leveraged trading. While it can magnify your profits, any losses you make are amplified in the same way. Similarly, rapid market movements – or market volatility – may help you gain profits in a short amount of time, but losses can happen just as quickly.
Derivatives also allow you to protect yourself against losses from falling share prices through practices such as hedging and diversification. We’ll explore how these work later on in this course.
Lesson summary
- We can use financial products to access the financial markets
- They can be grouped into complex and non-complex instruments
- Non-complex financial products don’t need specialist knowledge as they’re more simple to comprehend, whereas complex products require a deeper understanding of how they work
- The price of derivative products is drawn from the price of the underlying asset – if the real value of the underlying asset increases or decreases, its trading value also rises or falls respectively
- You can make profits from trading derivatives quickly because of market volatility. However, any losses can be just as rapid
- Leveraged trading gives you full exposure to the market you’re trading for a fraction of the cost it takes to make the trade
- While leverage can amplify your returns, your losses can be more than the amount you initially put into the trade
- Market volatility can help you make a lot of money on a trade, but losses can happen just as easily
