An image of commodity prices on a screen

When you ask most people about trading to invest their money, they normally think about the buying and selling of shares in a company on the stock market. However, there are more types of things that you can trade (buy and sell) on financial markets to make money than just shares in companies.

If you are new to trading financial securities (of which stocks/shares are a type) on financial markets, it can be very confusing to understand what all your options are. The people who work in the industry seem to have their own language and some of the things which you can do with your money seem very complicated to understand (which unfortunately some are).

In this online exercise on the types of financial trading, you will not only learn the different types of financial securities that you can trade or invest in, but also how they are traded.

The purpose of this exercise (which includes a reading exercise and then a quiz) is not to give you financial advice about how to invest your money on financial markets, but to help you to understand better what things are traded on financial markets and how.

Because of the complex nature of some of the terms you will learn about below, if you have any questions or uncertainties about what they are, after doing the quiz, click on the icon next to the term's answer which will give you more information about it.

Exercise: What you can invest in

Read the following conversation between two friends, Peter and Juan. They are talking about the different financial securities that people can invest their money in and advantages and disadvantages of doing so.

From the context, try to guess what the meaning of the words/phrases in bold are. Then do the quiz at the end to check if you are right.

Juan:'Peter, I was wondering if I could ask you about something.'

Peter:'Sure. What would you like to know?'

Juan:'I have quite a lot of money in savings. At the moment, it is all in a savings account in my bank. But I am sure there are better ways to invest this money. I have been thinking about buying some shares on the stock market. But to be honest, I have no idea about trading. Have you got any suggestions on what I can do?'

Peter:'One way of investing your money would be as you said by stock trading, the buying and selling of a company's shares which are traded on a stock exchange. But there are other financial securities that you can trade in to make money other than just the shares of a company.'

Juan:'Like what for example?'

Peter:'Another option is trading in currencies.'

Juan:'Like buying a lot of US dollars and then keeping them in the bank?'

Peter:'No. With currency trading, which is also called FOREX trading, you are not literally buying a currency, but buying a position on the exchange rate between two currencies (how many many euros you can buy with a US dollar for example) through a broker. You would make money if the exchange rate between the two currencies you have bought a position on goes up afterwards (i.e. you can now buy more euros with US dollars than when you bought your position) and then you sell it and you get the profit you made.'

Juan:'Currency exchange rates seem to fluctuate a lot. Are there other things I can trade in?'

Peter:'You can invest your money in bonds.'

Juan:'I have heard people talk about them before, but I have no idea what they are.'

Peter:'Basically, bonds are loans. A big company or a government borrows a large amount of money from some large financial institution (e.g. a bank) which then sells part of that loan/debt (in units of $1,000) onto investors on the bonds market through an exchange. And bond trading is the buying and selling of these on an exchange.'

Juan:'Why would anyone want to buy the debt of a company or government?'

Peter:'They are generally considered a low risk investment. There is generally a very high probability that you will be paid the $1,000 for each unit of the bond you have when the loan/bond reaches its expiration date (the date the borrower agrees to pay back the loan). In addition, as the owner of the bond, whilst it is active you will also receive regular interest payments from the borrower.'

Juan:'How much would you receive in interest payments?'

Peter:'It depends on the interest rate which was agreed in the original bond contract. It could be a fixed rate or a variable rate, it could be a high rate of interest or a low rate interest.'

Juan:'So, if I own some units of a bond, can I then sell them to somebody else before they reach their expiration date?'

Peter:'Yes, you can. However, the price which bonds are traded at does vary. They go up and down from the original unit price of $1,000.'

Juan:'Why?'

Peter:'For a variety of reasons. If national interest rates increase (or are predicted to rise), then a fixed interest rate bond is seen as a less profitable investment and less people will want to own it. Or maybe there is a fear that the borrower won't be able to pay the loan back in the future, and that will affect the price that a unit of the bond is traded at.'

Juan:'Ok. Maybe I should invest my money in gold. I have seen on the TV when there are problems in the economy people talking about it as a safe investment.'

Peter:'Generally, I would say it is in the long-term. But like anything which is traded on an exchange, its price does vary.'

Juan:'Are there other types of physical products which you can trade?'

Peter:'Yes, there are lots of commodities which are traded.'

Juan:'Like oil, coffee or cars.'

Peter:'Oil and coffee yes, but cars, no. With commodity trading, only basic raw materials like oranges, cotton, beef, milk, copper, gas etc... are traded, finished products like cars, pens, microchips etc... are not.'

Juan:'I know from going to the supermarket that the price of beef, milk or oranges varies between week to week. So I presume that the price of commodities on exchanges fluctuates a lot.'

Peter:'Yes, it does. So many variables (like the weather, state of the economy etc...) can affect the unit price of any commodity. So, it can be risky.'

Juan:'It sounds like I should keep my money in the bank. Even with investing in bonds, there is a risk of losing money.'

Peter:'But there is also the chance of making more money then you would if you just kept it in a bank.'

Juan:'If you know what you are doing. And I don't!'

Peter:'It does help a lot to get advice about trading anything from someone who has long experience doing it. It also helps to limit any potential losses to not invest your money in just a couple of financial securities (e.g. invest only in stock in Apple and oil) but to spread your money across lots of different financial securities. So if the price of one of them goes down, you are not losing a lot of money.'

Juan:'That makes perfect sense, but it is knowing which ones to invest in. And also it would cost a lot, because don't you have to pay a commission to a broker each time you trade a financial security like a stock or currency? '

Peter:'Yes, you do. In that case, there is another type of trading which may be good for you. And that is called fund trading.'

Juan:'What are funds?'

Peter:'Funds are investment companies which own a variety of different financial securities (e.g stock in a group of different companies, different bonds, commodities and currencies) and are run/managed by experts in trading.'

Juan:'So instead of me individually buying stock in different companies or different currencies etc..., I could just buy shares in one fund, who has already done it for me?'

Peter:'Basically. You can buy shares in them through your broker and depending on the type of fund it is, that will either happen straight away or at the end of the working day.'

Juan:'So I reduce my risk of losing a lot of money by buying shares in a fund then?'

Peter:'I would say so in general, but there is still a risk. However, the risk varies depending on the fund that you buy shares in. With some, like index funds, there is a lower risk of losses over the long-term, whereas with others there is a higher risk of losing money. It depends on what and how the people who run the fund invest in.'

Juan:'As I know very little about trading financial securities, investing my money in funds sounds like the best option for me.'

Peter:'Probably.'

Juan:'Just one more question. While I was watching some videos online about trading, I heard a couple of times people talking about trading derivatives. What do you own when you buy a derivative? '

Peter:'You don't actually own a financial asset when you use a derivative.'

Juan:'Sorry Peter, but that doesn't make any sense.'

Peter:'With all the other types of trading which we have talked about before, when you buy shares in a company on the stock market or units of a commodity on the commodity's market for example, you are in effect the owner of the asset. When you use a derivative contract, you are not. You have only entered a contract with someone else (e.g. an investment bank, a brokerage firm etc...) where you agree to buy from them or sell to them at some point in the future a specific quantity of a financial security (e.g. shares in a particular company, a particular bond, a particular currency etc...) at a specific price.'

Juan:'And what would happen if I decide that I no longer want to buy the asset that the contract I have entered states that I have to.'

Peter:'It depends on the derivative contract you have. With one type you have the option in the contract to not buy it if you don't want to. Whereas with another type if you still own the contract when it expires, you are legally obliged to do so.'

Juan:'You said 'still own the contract'. Does that mean that I can sell the contract before it expires to somebody through an exchange.'

Peter:'With most types of derivatives you can trade them through your broker. And just like buying stock or currency or bonds, their price does vary. If a derivative contract looks like it is going to make its owner money (e.g. the price the contract states you will buy a unit of a commodity at is less than the current price of that commodity) then the price you can sell that derivative contract for will be higher than if it looks like the contract owner will lose money (e.g. the price the contract states you will buy a unit of a commodity at is higher than the current price of that commodity).'

Juan:'So a derivative is just a contract where the owner agrees to buy or sell assets in the future, isn't it?'

Peter:'For most types of derivatives, basically yes. However, there are many different types of derivative contracts.'



Quiz:

Match the words/phrases in bold from the above text to each of the definitions/descriptions below. Click on the "Check" button at the bottom of the quiz to check your answers.

When the answer is correct, two icons will appear next to the answer. The icon contains extra information about the word/phrase. In the icon, you can listen to the pronunciation of the word/phrase.

1. A type of trading where people buy and sell units of specific raw materials and agricultural products, is called

         

Commodities trading:
(noun) In many ways it is very similar to trading stocks on the stock market. But instead of buying units of ownership in a company, you buy a contract of ownership of units of basic raw materials (e.g. wheat, cotton, beef, zinc, copper, oil, gas etc...) on a commodities exchange (though traders don't take actual possession of the commodity they have bought).

Trading often happens with futures, where a trader enters into a contract with a broker to buy a specific commodity at a set rate (often the current price) at a specific date in the future. If the value of the commodity goes up in the meantime, the trader has made a profit. If it falls, the trader has made a loss.

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Commodities trading:
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2. A type of trading where people buy and sell shares in companies who specialise in making investments in a wide variety of financial securities, is called

         

Fund trading:
(noun) In order to reduce your risk of losing all your money when owning financial securities (e.g. stock, bond, currency etc...), it is a common and recommended practice to diversify your investment portfolio (i.e. to invest your money in a variety of different company stocks, bonds, currencies and commodities). Although it is possible for an investor to do this themself (by individually buying stock from various companies, different bonds etc...), it is both costly (in terms of trade commissions) and time consuming (in terms of both doing and managing) to do.

A much easier way to do this is by investing in funds. Basically a fund is an investment company which owns a variety of financial securities (whether it be stock in a group of different companies, a variety of different bonds, a variety of different commodities, a variety of different currencies or a mixture of them) and then sells shares in the company to other people. Investors buy shares in them through their broker and like stock in an individual company, their price can fluctuate.

There are a variety of different types of funds to invest in. They differ in how and when they can be traded (some are 'mutual funds', while others are 'Exchange Traded Funds' (ETFs)). In addition to this, the financial securities which the fund contains will differ from one from the other. This means that some are higher risk to invest in than others. And lastly, some funds are passively managed (where the fund only invests in stock contained in a specific stock market index like the S & P 500, the Dow Jones 30, the FTSE 100 in order to replicate its performance) while other are actively managed (where the people who run it actively trade securities to hopefully make more profit for the entity and its owners).

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Fund trading:
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3. Contracts between two parties where one agrees to buy and the other to sell specific financial assets (e.g. shares in a company, currency etc...) from each other at a specific price at a point in the future, are called

         

Derivatives:
(noun) Instead of actually buying or selling the ownership of a financial asset (like stock in a company, currency, bonds etc...) or a commodity (e.g. gold, oil, wheat etc...) traded on an exchange, you can make an agreement in a contract with someone to do something connected to a financial asset. This could be to buy or sell a specific quantity of a financial asset at a specific price at a specific point in the future. These contracts are called derivatives.

These are numerous different types of derivative contracts (like futures, options, swaps etc...) and they are often used by the people who use them to limit potential losses (referred to as 'hedging') when investing their money in financial securities (although the opposite can be true, especially for the people who have to honour the contract if the value of the actual financial securities the contract relates to doesn't go as they predicated).

Many (but not all) of these derivative contracts can also be freely traded between investors/traders before they expire or are taken up. As a result of changes in the market value of the financial asset they refer to, the value of derivative contracts varies depending on how potentially profitable they are for the person owning them. If, for example, you have a contract to buy stock in a specific company at a specific price at a specific time in the future (in a futures contract), and the price of that stock is doing a lot better than anyone would have predicted at the time of creating/writing the contract, then that contract is seen as more profitable and its value would increase as a result. If the reverse happens, then its value would decrease.

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Derivatives:
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4. A type of trading where people buy and sell shares in companies which are listed on a stock exchange, is called

         

Stock trading:
(noun) This is the trading of shares/stock of public companies on a stock exchange. When a person buys shares on the stock market of a company, they in effect become an owner in the company. As a result they would normally receive a dividend if the company is performing, e.g. making a profit. The total amount they would receive would depend on how many shares they have in the company.

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5. A type of trading where people buy and sell the ownership of parts of loans made to governments and large companies, is called

         

Bond trading:
(noun)A bond is basically a type of loan/debt where investors (often large financial institutions) lend money to governments (normally national but also regional or local (e.g. a US state)) and public companies (those which are listed on the stock market). After this bond has been issued, units of this bond are then sold on the primary bond market to other investors in units of normally $1,000.

With a bond there is an agreement to pay back the principal (the amount originally borrowed (also called the par or face value)) at a specific date in the future (called the end or maturity date). Whilst the bond is still active, interest payments (known as coupons) are regularly paid from the organisation who borrowed the money to the current owner of the bond. The interest paid varies depending on the bond and the risk of the borrower defaulting on paying back the principal of the bond at the end. So the higher the risk, the higher the interest rate.

After the original lender/creator of the bond has sold units on the primary bond market, the trading of them happens on the secondary market, where investors buy and sell bonds between each other. Like any traded financial security, the price at which a unit of a bond is traded at changes (it can go up and down from the $1,000 it was originally sold at on the primary bond market). This happens for a variety of reasons, like how long is left before it matures/ends, the situation in both the economy and for the issuer of the bond (the organisation which borrowed the money). But normally the factor which has the biggest effect on the price of bonds are national interest rates; the higher these are, the lower the price of the bond.

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Bond trading:
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6. A type of trading where people exchange (although not literally) the money/legal tender of one country for that of another country, is called

         

Currency trading:
(noun) Often called FOREX or FX trading.This is where people trade different currencies (the money/legal tender of a particular country or group of countries, e.g. US dollars, euros, yens etc...) in order to make money. This type of trading is on the Foreign Exchange market (called FOREX) which is a worldwide electronic market.

With FOREX you buy a contract (not the actual currency itself) through a broker/brokerage firm to exchange a specific quantity of one currency for another (e.g. exchange US dollars for euros, GB pounds for Japanese yen) in what is called a 'currency pair'. You make money if the exchange rate (how many euros (called the quote currency) you could buy with one US dollar (called the base currency)) goes up after you have bought the currency pair contract. If it has, you would sell your contract and the money you have earned would be credited to your trading account (in the currency your account is set up for). In a way it is like making a sports bet.

For example you could buy a contract of say 1000 units (0.01 lot) of the currency pair USD:EUR (where you exchange US dollars with euros). When you buy the contract one dollar would buy you 1.1145 euros (called the 'spot price'). In order to make money, you would want the value of the euro to fall relative to the US dollar, say one US dollar would buy 1.1204 euros. In this case, if you sold the currency pair (called 'closing your position'), you would make a profit on your currency pair contract.

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Currency trading:
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To learn more about derivatives (and the five most commonly used types), I recommend you now do our online exercise called 'Types of derivatives'.




Practice

Now that you understand the meaning of the words/phrases and when to use them, practise using them by creating your own sentences with them in English. Also click on the "" icon next to each correct answer and listen how each is pronounced correctly.