By Mitchell Ho Jia Le
Introduction
Do you remember when you were young? Perhaps your mother or grandmother brought you to the local supermarket or the fish market to buy groceries? Or, if you are a history nerd like myself, the word “market” invokes images of bustling market centres in the Middle East where traders are doing their best to sell their goods to customers. That is the source of the word “market” that we are familiar with today.
Financial markets can be referred to as a broad spectrum of securities trading, which includes the 1) stock market, 2) bond market, 3) commodities market, 4) foreign exchange (“forex”) market, and 5) derivatives market. These markets are essential to the proper functioning of a capitalist economy, facilitating easy and smooth trading between people of their financial assets.
1) Stock Markets
When you hear the word “market” within the financial context, I am sure that you may be thinking of the stock market. So what is the stock market, exactly?
When a company goes public, it will list its shares as stock on the market (hence, stock market). These shares will then be bought and shared by investors. But why would companies want to list their shares on the market for investors to purchase and sell? It is essentially to raise capital for the company and for investors to look for good returns when they make the initial public offering (“IPO”).
Usually, the stakeholders in the stock market are investors, traders, market makers, and specialists who maintain liquidity; providing two-sided markets.
Take, for example, you want to build a house, but you lack the money to do so. You then decide you will sell certain rooms in your house to other people to raise money to build it, and once it is completed, the investors of your house will own certain rooms or objects in your house. They could choose to keep it and watch its value grow as the house’s value grows, or you could just buy it back from them.
2) Bond Markets
Now that you are familiar with how the stock market functions, the bond market essentially functions similarly to the stock market, albeit with a slight difference as a financial instrument.
A bond is essentially when an investor loans money for a defined period at a pre-established interest rate.
The usual issuers of these bonds are corporations and governmental bodies. Have you heard of “Treasury Bonds”? That is what the Department of the Treasury in the US sells for a 20 or 30-year loan period until they “mature” at a fixed interest rate.
3) Commodities Markets
Remember the analogy above of the bustling market in a crowded city centre of people selling goods and services to each other? The commodity market is essentially that.
Producers and consumers meet in this market to sell physical goods such as agricultural goods (e.g. beans, livestock) or even precious metals (e.g. gold).
One of the most notable and increasingly relevant commodities that are being traded between stakeholders is, in my opinion, energy commodities. This could vary from oil to carbon credits. With the global economy so reliant on energy consumption right now and the rush towards green energy, this market is emerging to be an increasingly relevant and important commodity.
4) Forex Markets
Before you travel to Europe, for example, you want to exchange your pound Sterling for euros, right? But when is the right time to do so? When the Euro’s exchange rate has fallen slightly as compared to the Pound Sterling? These are the decisions taken every day by people like you and me and are directly concerned with the foreign exchange markets.
Did you know that approximately USD$7.5 trillion is being traded daily in 2022, according to Compare Forex Brokers?
The forex market is a gathering place for investors to trade and speculate on exchange rates between pairs of currencies. This market is the most liquid in the world right now and is incredibly flexible and volatile as compared to the other markets mentioned.
5) Derivatives Markets
A derivative is essentially a contract between two or more parties whose value is based on an agreed-upon underlying asset or set of assets. Such derivatives could include future contracts, options, forwards, etc.
Thus, derivatives could be individual or groups of assets, like those that have been listed above (e.g. stocks, bonds, currencies or commodities). Derivative markets are essentially betting on the future of these assets.
To be frank, derivative markets are difficult to understand for first-time investors as they involve a lot of speculation and assumptions, especially with the grouping together of different assets when it is just easier to start with a simple market like stocks and bonds.
Conclusion
Well, these are some of the different types of markets that you will encounter on your journey towards understanding it. Whilst not overly complicated, it will take some time to understand the different types of assets that are being traded and how they are even being traded in the first place.
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