Trading instruments

There are several financial products nowadays. As technology has developed, several derivative products have appeared - products which price depends on the price of an underlying product.

You can trade any easily with these products on the exchanges: securities on the stock exchange, and commodities, wheat, and oil on the commodities exchange. The different products are traded on different exchanges with different capital requirements and unique risks.

It might be difficult for beginners to decide which instrument to trade. If you want to become a professional trader, you should choose products at the beginning of your career that are the most interesting for you.

Most beginners usually start on the Forex and CFD markets, since those are easily accessible and do not require high capital on their accounts. However, brokerages offering services regarding these products may expose traders to higher risks than regulated brokers.

In order to help you choose products, we have collected several aspects and characteristics of the different products. 

*The categorisation only reflects the author’s personal view

*The categorisation only reflects the author’s personal view

*The categorisation only reflects the author’s personal view

*The categorisation only reflects the author’s personal view

*The categorisation only reflects the author’s personal view

Forex
(Foreign Exchange, FX) 

What is Forex?

Forex market is the legal marketplace of trading different currencies. Currencies are trade on decentralised exchange, there is no centrally determined price. This market is responsible for the largest volume, much larger than the combined size of stock and bond markets. 

Is forex trading recommended for beginners?

Despite its flaws, it is still recommended. Forex market is easily accessible, hence the popularity among beginners. It is a good place to practice trading and gain experience for later trading on regulated markets. The biggest advantage of forex markets is the high liquidity and the relatively low costs. The most popular trading platform is the MetaTrader, which is easy to use. You should be aware that brokers will follow all your moves, get know your strategy, and might use this information against you.  

How much starting capital is recommended for forex trading?

Several brokerages offer accounts with low initial capital, which may sound tempting. However, you can lose all your money very easily with only a small amount on your account. To try out trading, you only need a few hundred dollars. If you want to become a professional, you will need thousands of dollars on your account. You should be careful with forex trading because of the large leverage. With large leverage, you can open positions much larger than your account which can result huge losses if your risk management strategy is not adequate. In 2018, the ESMA (European Securities and Markets Authority) has limited leverage to 30:1 in order to protect traders.  

What risks are associated with forex trading?

One risk factor of forex trading is the broker company itself. In most cases their headquarters are in Cyprus or Malta to take advantage of the low control and beneficial taxation. There have been cases when seemingly stable brokerages have suddenly disappeared with the money of their clients. It’s important to highlight that forex markets are decentralised. This means that the prices are determined by brokerages. Therefore, unlike on centralised markets, brokerages are not only intermediates in the trades but also participants. It often happens that the quoted price differs between two brokerages. An example for this is the street currency exchange that determine the rates themselves. It may also happen that the broker manipulates the price by triggering your stop order, generating a loss for you. Beginner traders tend to neglect interest rates, which may have harmful effects especially in the long term. 

What are the costs of forex trading?

The costs are determined in the bid/ask spread since they determine the difference between the bid and ask prices. The costs are hidden this way, which is one of the typical characteristics of decentralised markets.

 

Binary option

What is binary options?

Just to make it clear at the beginning: binary options are closer to gambling than to trading. Binary options are very simple: as the name indicates, you have to guess whether the price will increase or decrease in an upcoming period (e.g. 1 minute, 1 hour, etc.). You can bet on the price movement. 

Are binary options recommended for beginners?

Absolutely not. Binary options have nothing to do with real option trading and it’s more like gambling. 

How much starting capital is recommended for binary option trading?

You can open an account with low initial value, but it’s not recommended. It may seem simple, but my recommendation is not to start trading with binary options. 

What risks are associated with binary option trading?

Brokerages offering binary options usually lure clients with attractive commercials, high return promises, and made up success stories. They promise unrealistic returns and make you believe that trading is very simple. You’ll lose the bet if you guess the direction wrong. You’ll win the bet if you guess the direction correctly. However, you’ll only get back a certain percentage of your investment. Just like in casinos, the brokerages have the advantage. You should know that your transactions aren’t happening on a regulated market and your orders will not be routed to any markets. The goal of firms offering binary options is to take your money. Your gain is their loss, therefore clients making profits will get excluded from the market. Never trade an instrument where the broker is trading against you and has an advantage over you. Since the ESMA regulations, the adverts of binary option trading firms seem to diminish. 

What are the costs of binary option trading?

Most firms offering binary options say that there are no transaction fees. This is not true. The pay-out ratio is usually around 80%, so the expected value of you return will be negative even if you win the bet 50/50. It doesn’t matter that you won if you only get back a certain percentage of your investment. You lose the full investment if you lost the bet.

 

CFD
(Contract for Difference)

Whati is CFD

CFD is a derivative instrument following the price of another product (Underlying). A CFD is an tradable instrument based on an underlying asset or financial instrument such as a share, commodity or currency pair. With a CFD, you decide whether you think the underlying asset will rise or fall in value between the time the contract is opened and when it is closed. 

Is CFD trading recommended for beginners?

It is recommended to try out, despite its risks CFD trading is very popular. You should know that buying a shares CFD you do not own the shares, you own the contract provided by the CFD provider. Therefore, you don’t have any ownership rights and you are not entitled for dividends - as you would be when buying traditional stock. The biggest advantage of CFD broker is that it can integrate the different products into a specific structure, making oil, gold, stock, or index easily available. 

How much starting capital is recommended for CFD trading?

Few hundred dollars are enough to start trading due to the low margin requirements of CFDs. However, smaller account size always means higher risk. An incorrectly sized position can increase the margin and can make you run out of capital easily. Additionally, your diversification strategy will be less efficient with small account size. 

What risks are associated with CFD trading?

Many say that CFDs are popular because it requires less capital than buying the stock itself. This is true, but there are several risks coming with the beneficial capital requirements. Due to the leverage, most CFDs will have an interest charge if you keep it longer than a day. Furthermore, instead of ownership rights, you will only have a contract with the brokerage. CFD trading - like forex and binary option trading - takes place on non-regulated markets. It’s also typical here that the brokerage doesn’t routed the order to the market but deals with it in-house. It can happen with CFD trading that you lose your capital partially or completely. It is also possible to lose more money than the amount you have on your account. Public statistics show that 70-80% of retail CFD traders are making losses. 

What are the costs of CFD trading?

The broker might build the cost in the spread - like in forex trading. Some brokerages might charge additional commission fees. In conclusion, CFD is more expensive than trading the regulated underlying.

 

Stock

What is stock?

Stocks are securities embodying ownership. You will become part-owner of the company issuing the stock after you buy it. Shares are traded on regulated markets - unlike CFDs. This means that the only role of brokerages is to transfer your order to the market as soon as possible. 

Is stock trading recommended for beginners?

Absolutely! If you want to try trading seriously, you should go to the real market where the parties are equal. You will always find stocks matching your strategy due to the large number of companies on the stock exchange. You must differentiate between stock trading and stock investing. Investing is when someone buys stock and doesn’t sell it for a long time (Buy&Hold). On the other hand, trading means constantly buying and selling stock, which requires more preparation. 

How much starting capital is recommended for stock trading?

Stock trading is a real profession. It is not enough to open an account with a few thousand dollars anymore. In the US you’ll need USD 25,000 on your account for daytrades. Leverage is limited in stock trading to protect traders. Most brokerages offer 4x leverage for daytrading and 2x leverage for overnight positions. 

What risks are associated with stock trading?

The advantages of regulated and concentrated markets that the prices are the same, so the broker cannot manipulate the price and make your position flat by triggering your stop order. There are rules to protect the clients of brokerage firms that are forced into (SIPC). Depending on which country you opened the account, different deposit insurance policies will protect your capital up to a certain limit. Naturally, stock trading is risky. The reaction of stocks on corporate events can be more volatile than the reaction of indices or currencies. Volatility can be quite high, it is possible to have a 5-10% movement during a trading day. You will need serious risk management and position management systems if you want to trade stocks. 

What are the costs of stock trading?

You need a securities account at a brokerage to trade stocks. Account management is free for most brokerages, but commission fees can be significant. Commission fee can be determined on a percentage basis (typical for European brokerages) or based on the number of shares traded (typical for US brokerages). Here the fees are not built in the spread since brokerages aren’t allowed to manipulate prices. Commission fees are usually negligible relative to the value of the investment.

 

Futures

What is Futures?

Futures are similar to options. The difference is that futures are contracts about obligation, whereas options come with a right to sell or buy. In other words, the buyer of the futures contract (long position) must buy the underlying product and the seller of the futures contract (short position) must sell the underlying product at a predetermined date. If the price of the underlying is higher than the predetermined price at the expiration date, then the buyer of the contract will have a profit since he can buy the product for a lower price than the current market price. Futures contracts are standardised, meaning that exchanges determine the size, the quality, and the expiration date - the traders only need to negotiate the price. 

Is futures trading recommended for beginners?

This question isn’t easy to answer. I would recommend it to beginners because futures trading will provide you real exchange experience. There is no price manipulation by brokers and they aren’t hunting stops. On the other hand, I wouldn’t recommend it because it requires large capital which is easy to lose as a beginner. Futures trading is the only choice of those who’d like to trade oil, gold, indices, or agricultural products on a professional level. 

How much starting capital is recommended for futures trading?

The margin requirements of futures trading are high. This means that you have to deposit several thousands of dollars on your account to open a position. In my opinion, you shouldn’t start futures trading below USD 30,000 account size. Futures are ideal for speculation or hedging. 

What risks are associated with futures trading?

The trading takes place on a regulated market, the brokerages are intermediates. There may be large price swings on futures markets as well - typical example is the oil or gas futures prices. Due to the large margins for one contract, your capital can quickly disappear. 

What are the costs of futures trading?

You need several dollars on your margin account to open a single position and hold it. However, there are several advantages of futures trading, such as its high liquidity - assuring us there will always be a seller or buyer on the futures market. Futures prices can be influenced by interest rates and the storage costs of the underlying product (Cost of Carry). The commission fees of futures trading are usually negligible.

 

Option
(Vanilla option)

What is option?

Option is a contract where one party has a right to buy or sell a given security. Simply put: the option provides a right to its buyer and an obligation to its writer. It is one of the most complicated financial instruments. One of the creator of the option pricing model (Black-Scholes) has been awarded a Nobel prize in the 90s. Options are derivatives; therefore, the price of the option is depend on the price of an underlying product. The underlying can be stock, forex, index, or futures. Vanilla means that this option type is the simplest. 

Is option trading recommended for beginners?

Option trading is not for beginners since the option price is not only influenced by the underlying price but also by interest rates, volatility, and time until expiration. Option trading is a beautiful profession, gives the trader freedom and almost every market situation can be traded with options. However, do not start your career with options. You should first learn how to analyse the underlying and gradually prepare for option trading. You can build non-directional strategies with options to make yourself independent from price movements. The reason many people start option trading is that they don’t have to guess the direction of the price with these strategies. This doesn’t mean that delta neutral option trading is easier than directional trading. 

How much starting capital is recommended for option trading?

Options are leveraged products; hence it is possible to earn high returns in a few days while the risk is limited even in extreme market conditions. There are option strategies with capital requirement of only a few hundred dollars. However, it is not recommended to start trading with such low amount. Brokerages usually recommend USD 10,000, but you can only daytrade US options if you have at least USD 25,000 on your account. It is possible to trade options on margin accounts (less capital than using cash account) and it can happen that you have to deliver the underlying product. This may increase the capital. 

What risks are associated with option trading?

Option trading is also regulated, and the broker is only an intermediate in the trade. The biggest advantage of option trading is the high level of risk management. It can be risky, but with adequate risk management the risks can be minimised. With option trading you will be able to trade with limited risks and you will no longer have to use stops. The biggest risk of option trading is selling naked (uncovered) options, where you can have unlimited risk (theoretically). Further risk is the negligence of the price influencing factors (or inadequate knowledge) which can lead to unexpected events. It is important to emphasize that your stock or index portfolio can be hedge by correctly applying option strategies.  

What are the costs of option trading?

Option trading is relatively cheap. You can open a position below 1 dollar per leg without any hidden charges. On liquid option markets the spreads are tight, hence you can open and close positions with minimal difference between the opening and closing price. The costs of a good option strategy are negligible relative to the returns. In complex option strategies the combined costs of all legs might reduced the performance of your strategy.

 

Bond

What is bond?

Bonds are securities embodying credit relationships. The two parties are the borrower and the lender. The issuer of the bond will take on the obligation to repay the face value with additional coupon payments to the buyer of the bond on a specified date a predetermined way. Bonds - unlike stocks - do not provide ownership rights, the right of the bond owner is the right for the payments specified by the issuer. 

Is bond trading recommended for beginners?

Yes, if you are planning to invest instead of trading. You will achieve low returns in exchange of low risks. Bond positions are not recommended to change frequently, since the costs will exceed the returns. The price of the bond cannot be analysed with the traditional tools of technical analysis. In bond trading you’ll need to know about fundamentals and about the environment of the corporations and their economic environment. 

How much starting capital is recommended for option trading?

You need large initial capital. Most bonds have an EUR 10,000 face value. However, there are even larger ones, e.g. EUR 100,000. In the US smaller investors have the opportunity to buy bonds: one can buy bonds for USD 1,000 face value. 

What risks are associated with bond trading?

Bonds have their specific risks. The most important is the credit risk, when the corporation will not pay back your money. Credit risk is your risk, the investment protection guarantee will not cover your losses. The more uncertain the future of a firm, the higher credit risk you need to take on. However, you will have advantage over stock owners if the company defaults since the creditors are compensated from the owners’ money and will get their money before the owners. 

What are the costs of bond trading?

Corporates and government bonds are traded on the OTC (Over The Counter) market, hence the price of the bonds might differ. Brokerages build the costs in the bond price. Bonds cannot be traded like forex or stock. The spreads are much higher; thus, it is not worth to buy and sell bonds frequently.

 

ETF
(Exchange Traded Fund)

What is ETF?

ETFs have revolutionised the market of investments. An ETF (Exchanged-Traded Fund) is an innovative investment fund that can be bought or sold like stocks. An ETF offers you the diversified portfolio of a mutual fund with the ease of trading stocks. You can invest in various products with ETFs: stock, forex, bond, oil, etc. 

Is ETF trading recommended for beginners?

ETFs are stable instruments and easy to diversify dut to the small trading unite. ETF trading is very similar to trading stocks: ETFs are also liquid instruments, so trading is recommended for beginners. They are also flexible, because you can also short them. If you want to avoid shorting, you can find ETFs where the price increases when the markets are in a descending phase - they are inversely following the market moves. 

How much starting capital is recommended for ETF trading?

The same applies as for stock trading. You need USD 25,000 for daytrade, but less is enough if you are planning to hold your position longer than one day. Brokerages usually allow ETF trading around USD 10,000 account size.  

What risks are associated with ETF trading?

One of the risks is the presence of leveraged ETFs, which can react to changes on the market 2 or 3 times faster. This attribute attracts risk-seeking investors and beginners may also find it attractive. Without enough experience the leverage means high risk. Another risk is the erosion of ETFs - they are continuously losing value over time. 

What are the costs of ETF trading?

One of the biggest advantages of ETF trading is its cost. You will have to pay commission fees - similar to stock trading - which will be negligible relative to the size of the investment. The expense ratio represents all the expenses of the ETF divided by assets. This metric includes all internal costs of the fund, such as items we sometimes see itemized in a prospectus, like the management fee, which is how much an issuer charges for its fund management services. And the way it’s collected is not as an upfront fee at the time of purchase. The expense ratio is accrued daily in the net asset value calculation of the ETF, which makes timing crucial in the calculation. If you bought a leveraged ETF with a 2% expense ratio, but you only held it for a week, you’d pay less than 0.04% in fees.

 

Crypto currency

What is crypto currency?

Crypto currencies are digital money. It differs from the widely-used non-digital money because your money is not managed by a bank, but by users all over the world. Anyone can access most of the crypto currencies. There is no central bank or institution overseeing the transactions. However, due to the blockchain technology, every transaction is administrated and tamper-proof. The first crypto currency on the market was Bitcoin, developed by Satoshi Nakamoto in 2008. In the past decade several new crypto currencies have emerged. Some of those have tried to correct imperfections of Bitcoin: e.g. with faster transaction confirmation, higher security, smarter contracts or with better data protection. 

Is crypto currency trading recommended for beginners?

Yes, but only with low amount. It may seem like forex trading but the different roles of the participants of forex trading are blurred: there is no central bank (only issuing firms), the trading is not taking place on the international interbank market, the orders are executed by the firms operating the platforms, and the same firms are also responsible for the settlement of the orders.  

How much starting capital is recommended for crypto currency trading?

It depends which way you want to trade crypto currencies. You can primarily trade them on crypto exchanges with a relatively low amount on your account, but different leveraged crypto CFDs have also appeared. You can choose among the Bitcoin futures products of CBOE and CME if you would like to trade Bitcoin on a regulated market. Not only hedge funds can join the market by introducing futures and ETFs, but also retail traders that didn’t want to deal with digital wallets and unregulated crypto markets. 

What risks are associated with crypto currency trading?

Crypto currencies are very risky investments. They are highly volatile, hence it’s easy to lose a significant amount of your investment. There is no regulatory institution monitoring crypto currency trading. There have been cases of hacking Bitcoin exchanges and stealing money from clients. 

What are the costs of crypto currency trading?

The biggest costs arise during conversion. Apart from the spreads, some crypto exchanges charge extra commissions.