What are financial markets?

The Concept of Financial Markets

The definition of financial markets is not much different from the concept of a market that we know. Financial markets are places or entities where sellers and buyers meet to execute transactions or trades. The seller wants to sell an asset and offers it for sale in exchange for a certain amount, while the buyer wants to acquire the asset and submits a purchase request. In this case, the asset is a financial instrument, and the role of the financial market is to facilitate the buying or selling of the financial instrument. Financial instruments can include stocks, bonds, commercial papers, and others.

Thus, we can say that financial markets are places or entities where offers and demands for trading financial instruments are available. This occurs in a regulated and centralized market through a specific platform such as a stock exchange or in an unregulated market known as over-the-counter (OTC) trading. A financial market is a market for assets, in various forms, that are tradable. It does not always require ownership of the asset or financial instrument to trade it; rather, it is a financial tool prepared for trading according to specific rules and regulations.

Function and Importance of Financial Markets

The importance of financial markets lies in their role in providing cash and liquidity to various commercial and economic activities, transferring saved funds after consumer spending on essential goods, and channeling them into investment opportunities by directing funds to sectors in need. The market accomplishes this through financial operations such as issuing securities, offering them to the public for subscription, and then trading them by selling offers or buying requests.

Types of Financial Markets

The types of financial markets vary depending on the financial instruments traded or the methods of trading. Some of the most important and well-known types of financial markets include:

1. Capital Markets: These are the most prominent and are divided into the stock market and the bond market.

   The difference between stocks and bonds is that while both are financial instruments, a stock represents a share in a company's capital, and bonds represent a part of the company's debt. Stocks are equal in value and indivisible by their owner and can be traded commercially. Bonds are financial instruments that confirm a loan to the company, entitling the holder to claim the loan amount plus interest by its maturity date.

2. Foreign Exchange Market (Forex)

   The Forex market is the largest financial market by trading volume and liquidity, known as Forex. Investors in the Forex market benefit from changes in foreign exchange rates by trading currencies from different countries. This involves exchanging one currency for another, buying currencies at a low price, and selling them at a higher price.

   The following video provides more information about the Forex market:

3. Commodity Market

   One of the oldest financial markets, the commodity market involves trading agricultural products such as wheat, sugar, cocoa, gold, and oil through contracts. These contracts can be immediate, forward, or future contracts, or through options contracts. Speculation on prices is also possible through Contracts for Difference (CFDs).

4. Cryptocurrency Market

   A relatively new market, the cryptocurrency market emerged with the advent of digital currencies, allowing traders to trade new cryptocurrencies similarly to traditional currencies. It is also called the cryptocurrency asset market, with transactions recorded on a blockchain.

Financial Derivatives

Financial derivatives are contracts whose value is derived from the value of underlying assets, allowing trading of the asset in different ways to achieve gains based on price fluctuations of the asset. Derivatives are available in all financial markets, including stocks, bonds, currencies, and commodities, and are used to reduce price fluctuation risks.

They are divided into:

1. Spot Market

   This market involves immediate trading of the financial asset at the current price. Even if the transaction takes a few minutes or longer, it is considered immediate if executed at the current price.

2. Futures Contracts

   These are agreements between parties to buy or sell a specific financial asset at a future date at its current price, either to achieve higher returns from expected future price increases or to reduce future price fluctuation risks.

3. Forward Contracts

   These are commitments to trade the financial instrument at a future date, similar to futures contracts, but differ in that they are not in random quantities but are standardized by regulatory bodies.

4. Options Contracts

   An options contract gives the holder the right, but not the obligation, to buy or sell the financial asset within a specified period, with the buyer paying an initial premium to the seller. This makes the contract optional for the buyer - either to buy, execute, or withdraw and lose the premium - while the seller is obligated to fulfill the contract if the buyer decides to exercise it.

Investing in Securities

Many people invest in securities to increase income and wealth while protecting funds from inflation and other factors. The general goal of investing is to achieve returns or profits from trading or investing, whether short-term, medium-term, or long-term, based on the investor’s future outlook for the traded asset.

Investors can earn returns in financial markets through:

1. Returns from the Traded Asset

   In the stock market, gains can be achieved from stocks owned through dividends received as a shareholder in the company’s profits.

2. Price Movements of the Traded Asset

   In the Forex market, investors can profit by buying currencies at low prices and holding them for a period before selling at higher prices, or trading through price speculation using leverage and margin to achieve greater returns with relatively smaller capital in less time.

Anyone, regardless of capital, can invest in financial markets through brokerage firms after learning how to analyze financial markets.

Analyzing Financial Markets

Before trading in financial markets, one must be able to predict future price trends. Success in trading largely depends on the ability to forecast price movements, which is where analysis comes into play.

Analysis generally means studying current and historical data to predict future trends. In financial markets, data available for analysis includes price data or financial and economic data based on the financial instrument being analyzed.

There are two main types of analysis:

1. Technical Analysis

   This involves studying historical and current price data on charts to predict future price trends without considering the reasons behind the movements. If the prediction is for an upward trend, the analyst may consider entering a buy trade, and if the prediction is for a downward trend, the analyst may consider entering a sell trade.

2. Fundamental Analysis (Economic or Financial)

   This involves studying economic, political, or financial factors related to a country or company based on the traded asset, identifying factors that influence supply and demand and assessing their impact on the asset’s price. This determines whether the impact is positive or negative, which in turn influences the direction of the asset’s price.

The following educational video provides more details on the differences between fundamental and technical analysis:

Conclusion

Understanding financial markets is crucial for anyone interested in trading or investing. These markets provide opportunities to engage in various financial activities, from trading securities and currencies to investing in commodities and cryptocurrencies. By analyzing market trends and using financial derivatives, investors can manage risks and potentially enhance returns. Familiarity with market functions, types, and analytical methods is key to making informed decisions and achieving investment goals.