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Financial Markets
Introduction to Financial Markets
Financial Markets and Institutions are a big term. There are a lot of components within
financial markets and a lot of things to cover. This is why we have prepared a complete
guide for you where you are going to learn about the basics and more advanced concepts as
well.
Table of Contents
 What are financial markets and institutions?
 World’s biggest centralized exchanges
 Structure of a decentralized exchange
Decentralized market
Main characteristics of a decentralized exchange
What is an OTC (over-the-counter) market?
Forex
Comparison for the retail trader
o Centralized market
o Decentralized market
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What are financial markets and institutions?
A financial market is a place that provides the ability to exchange different financial assets.
Through this exchange, you can buy and sell assets such as foreign currencies, stocks,
bonds, commodities etc., in exchange for money. A capital market is one of the main parts
of the financial market. Investors and issuers meet at the exchange every day. Issuers gain
funds at the exchange of their own business, while investors can gain ROI (Return on
investment). The exchange takes the form of a double-sided auction, where the final price
of the traded instrument decides the state of supply and demand. The price thus obtained is
called a course.
World’s biggest centralized exchanges
NYSE – New York Stock Exchange (USA) – The largest exchange in the world as measured
by the market value of securities traded
NASDAQ – National Association of Securities Dealers Automated Quotations (USA)
Euronext – European New Exchange Technology (Europe)
FWB – Frankfurter Wertpapierbörse – Frankfurt Stock Exchange (Germany)
LSE – London Stock Exchange (United Kingdom)
TSE – Tokyo Stock Exchange (Japan)
All the above-mentioned institutions are so-called centralized exchanges – being
characterized by the settlement of a transaction between the buyer and the seller. It is the
central place where the price is determined, settlement of trades is called the clearing.
On the contrary, a decentralized exchange is not physically or logically linked to one
particular place. The market, therefore, operates on the basis of a link between the
participants, without a central authority.
Structure of a decentralized exchange
Decentralized market
Decentralization is the very process of distributing the decision-making powers of central
authorities. Decentralization is one of the most attractive attributes of cryptocurrencies,
which cannot be controlled by any central entity. For example, in peer-to-peer systems, it is
Bitcoin which requires no central authorities for its transactions. Unlike centralized
exchanges and exchange bureaus, their decentralized “sisters” are just a kind of interface
that connects two people who want to make a shift and the rest is on these participants.
Main characteristics of a decentralized exchange
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Allows its clients to have control over their own resources
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Does not have a central server that could become the target of cyber attacks
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Not controlled by an individual or a narrow group of people
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Respects the privacy of its clients and does not require lengthy forms of
registration or fulfilment of KYC (know your customer) standards
The decentralized exchanges also include the foreign exchange market. In regards to forex,
we use the term OTC.
What is an OTC (over-the-counter) market?
OTC (over-the-counter) market is a decentralized market without a central physical
position, where market participants trade with each other through various means of
communication, such as telephone, email, and proprietary e-commerce systems. In the OTC
market, traders act as market makers by stating the prices at which they buy and sell
securities, currencies or other financial products. A trade can be made between two
participants in the OTC market without others being aware of the price at which the
transaction was completed. In general, the OTC market is usually less transparent than
stock exchanges and is also subject to less regulation. The OTC market is primarily used to
trade bonds, currencies, derivatives, and structured products.
Forex
The currency market is the largest and most liquid financial market in the world. Trading is
allowed 24 hours a day, 5 days a week through repeating Asian, European, and North
American sessions. Thanks to the boom in online trading, it is available to almost everyone.
The average daily trading volume is around “$7.5 trillion” (In 2022. Source: bis.org),
which is about 10 – 15 times more than the daily volume of trades on the world’s stock
markets. The currency market is decentralized, there is no specific trading floor such as
NYSE for trading stocks.
Forex, therefore, has the character of an OTC (over-the-counter) market. It works on the
basis of the connection between dealers and traders.
Comparison for the retail trader
Centralized market
The centralized market is characterized by high standardization in terms of the size of
traded contracts, trading hours, and a uniform price for all participating brokers. The
market is heavily regulated and completely transparent. It offers a wide range of products
but is highly capital demanding.
Decentralized market
A decentralized market is characterized by different trading conditions, contract sizes, and
trading hours among brokers. Even the prices of the same instruments may vary between
brokers. However, the great competition between brokers means lower costs for traders
and this comes with the so-called leverage effect.
Instruments traded in the Financial
Markets
In this lesson, we will take a look at instruments traded in financial markets and
institutions. These are namely stocks, currency pairs, stock indices, commodities, and
cryptocurrencies. What are their specifications and what should you know about them?
Let’s find out!
Table of Contents
 Stocks
Why are stocks traded?
Types of stocks
How to trade stocks
Currency pairs
Stock indices
Commodities
Cryptocurrencies
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Stocks
A stock is a security that the owner becomes a shareholder of the company. A shareholder
has different rights. E.g. he/she is entitled to participate in the profit of the company in the
form of dividends but also to participate in the management of the company, inter alia, by
being entitled to vote at the general meeting or to participate in the liquidation balance of
the company in the event of a liquidation.
Why are stocks traded?
Firstly, there is an incentive for companies to raise capital by selling shares on the stock
exchange. Investor motivation is to evaluate their resources. The company’s liabilities are
guaranteed by shareholders only by their stake, which is the share price multiplied by the
quantity purchased.
Types of stocks
We distinguish stocks in terms of form on:
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Paper shares – physical documents
Dematerialized shares – shares entered into electronic records
Then the shares in the name of the natural or legal person, or shares of the
owner/bearer, are anonymous and no longer used today.
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How to trade stocks
Stocks can be traded on stock exchanges but also through CFDs.The stocks are traded
entirely online. Examples of significant shares: Microsoft, Apple, etc. For certain shares, we
use the term blue chip. These are the shares of the largest and most profitable companies,
being traded on the stock market exchange, having stable growth, and paying dividends on
a regular basis.
Currency pairs
Currency pairs are traded on the foreign exchange (also known as Forex), which is the
biggest market with a “$7.5 trillion” daily volume (In 2022. Source: bis.org). A currency
pair consists of two currencies, where one currency is called the base currency and the
other is the quote currency.
We trade currencies in such a way that we speculate on the strengthening of one currency
against the other currency. We can explain the relationship of currencies to the EURUSD
currency pair, which is the most popular and most frequently traded pair. In this case, the
base currency is the euro and the quote currency is the US dollar.
What does the EURUSD rate at the 1.12 level mean?
This indicates that 1.12 USD is required to buy 1 euro. The rate is always the unit of the
base currency.
Currency pairs are divided into 3 categories – majors, minors (or crosses), and exotics.
Other examples of currency pairs: USDJPY, AUDUSD, EURCHF.
Currency pairs are characterized by high liquidity and often volatility too, depending on the
fundamentals. Price usually moves up to 1-2% daily.
Stock indices
The stock index is the sum of many different instruments traded on one exchange. The
stock index is an indicator of the development of a given segment or economy of the
country as a whole. Most often, we have stock indices that reflect the value of shares traded
on a given stock exchange. For example, the most famous stock index of the Frankfurt Stock
Exchange – DAX, is composed of a share price by 40 most important selected German
companies. (BMW, Adidas, BASF, Bayer, Lufthansa, Siemens).
Examples of stock indices: Dow Jones Industrial Average, S&P 500, FTSE 100.
The value of stock indices varies based on the movement of all shares that are contained in
the index.
In general, indices are a stable investment instrument. As a rule, they are not volatile just as
any individual stock titles can be. Therefore, investment in indices is gaining increasing
popularity among investors.
Commodities
We can describe commodities as goods traded in markets without quality differences.
Deliveries from different suppliers are mutually substitutable. For example, a commodity
cannot be a car that is produced by many different means and at different prices. The most
well-known traded commodities are crude oil, gold, and natural gas, but also coffee,
corn, orange juice etc.
There are two types of traders on the market – the first (also being a minority) only
speculates on price development, while others are really buying that particular commodity.
For example, Starbucks secures its coffee supply a year in advance through the exchange.
For commodities, we need to take greater risks – their price depends on climate change,
global resource outages, trade wars, etc. It is important to understand that some
commodities are correlated to the certain currency of a particular economy. Correlation of
price developments between currency pairs and commodities:
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Crude oil – Canada
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Gold, iron ore – Australia
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Dairy products – New Zealand
 Natural gas – Qatar
There is also a need to monitor world affairs, macroeconomic data, population growth
demands, etc.
Cryptocurrencies
Cryptocurrencies are a type of digital currency or, in other words, electronic money. The
biggest problem or for someone else, the advantage is that electronic money is not
regulated. The most famous is Bitcoin; others are Dash, EOS, Ethereum, Ripple, Litecoin,
etc. The price changes of cryptos are very steep – e.g. Bitcoin in 2021 ranged from $29,000
to $64,000.
Trading Terminology
Table of Contents
 Forex
 Lot
 Leverage
 Margin
 Hedging
 Pip
 Bid
 Ask
 Spread
 Trading strategy
 Volatility
 Trading approach
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Scalpers
Day traders
Swing traders
Position traders
Broker
Limit/Market orders
Stop Loss/Take Profit
Reward to risk ratio – RRR
Trading sessions
Forex
Forex stands for FOReign EXchange. Forex is also known as forex trading, currency trading,
foreign exchange market or FX. It is an international trading system for the exchange of
major and minor currencies, i.e. the foreign exchange market, whose mid-range courses are
considered
as official world courses.
Lot
Lot is a measurement that we use in forex trading. One lot equals one hundred thousand
units. So if we buy 1 lot in EURUSD, our investment is worth $100,000. If you go long 1 lot
on EURUSD, one pip equals $10 of price fluctuation. Because EURUSD can move fifty to a
hundred pips a day, this can be a lot for traders with smaller accounts.
Because of that, brokers allow opening positions smaller than 1 lot, namely:
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A mini lot, which is ten thousand units.
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A micro lot, which is one thousand units.
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A nano lot, which is a hundred units.
Leverage
The principle of leverage is using a small amount of equity supplemented by substantially
larger amounts of foreign capital to finance the investment. This practice can magnify
profits but also losses. Leverage is, therefore, a tool that increases the size of the maximum
position that you can open as a trader.
For a better understanding, let’s give an example:
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Suppose a trader has a balance of $1,000 in his account, and his broker provides
a leverage of 1:500. $1,000 * 500 would be equal to a maximum size of $500,000
per position. In other words, the trader can trade orders 500 times greater than
the deposit. And this is the basic pillar of understanding leverage. If leverage
1:500 is utilized, the trader will earn $500 instead of $1 for the same investment.
Of course, it is important to emphasize that losses can be equally rapid.
Margin
The required amount of funds needed to participate in the market.
Trading on margin with leverage is a process in which a broker allows a trader to borrow
money (either from a broker or from an investment bank) and purchase a particular
instrument. Margin is the difference between the total value of an investment and the
amount provided to the trader.
Let’s take a look at a practical example on the platform:
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When we open 1 lot of EURUSD pair, the margin is what we must hold on the
trading account. For this example, when the leverage is 1:100, it is a minimum of
$1,000.
Hedging
In finance, the notion of hedging means creating a position in a particular market to
minimize risk from another position. There are many different tools through which you can
hedge. Some examples are insurance contracts, forwards, swaps, options, many different
over-the-counter derivatives, and arguably the most popular are futures contracts.
Futures exchanges arose in the 18th century to allow transparent, standardized and
effective hedging against the movement of prices of agricultural commodities.
Pip
Currency pairs increase or decrease by the value traditionally measured in the socalled PIPs (Price Interest Point, or Points in Percentage). PIP is defined as a “percentage of
one percent”, or 0.01%.
Traditionally, forex prices have been quoted in a certain number of decimal places – more
often to four decimal places – and initially, the PIP was moving by one point in the last
decimal place. Most brokers now dimension forex instruments in one extra decimal place,
which means that PIP is no longer the last decimal place.
The exceptions you’ll notice include currency pairs with a Japanese yen – for these pairs,
one pip value is the second decimal place, while the price mostly has three decimals.
We’ll give you an example:
Let’s say you buy a currency pair EURUSD for 1.11510 and later, you close your position at
1.11520. The difference between the two prices is: 1.11510-1.11520 = 0.00010-in other
words, the difference is just one PIP. The price of the financial instrument is always stated
in two values:
Bid
The bid represents the price of demand – i.e. the price for which the contract can be sold at
a given moment.
Ask
Ask represents the price of the offer – i.e. the best price at which the contract can be
purchased at the moment. The retail trader, therefore, always gets a less advantageous
price.
Spread
The difference between supply (ask) and demand (bid) is called a spread. It is, therefore,
the difference between the price claimed by the seller of the instrument and the price at
which the buyer is willing to buy. The spread is the expense that a trader must consider
while trading.
Trading strategy
The absolute necessity for every trader is the so-called trading strategy.
Each trader has his own financial objectives and acceptable level of risk, which influences
the choice of the financial instrument that he/she buys or sells, as well as the settings of
input and output limits, profit with stop loss, and analysis of a possible market direction.
All these factors combined set a specific trading strategy and give a trader an edge.
This edge is an important part of any trading strategy. If a trader does not have an edge,
then he/she hardly achieves favourable results in his/her trading.
Volatility
Volatility indicates the fluctuations in the value of an asset or its rate of return over a given
period of time and expresses the risk of investing in an asset. Volatility is an essential
heartbeat for a trader because it moves the price of the instrument up and down. When the
volatility is zero, the trader cannot make any profit or loss.
Trading approach
The trading approach is the same as a trading strategy. It differs for every trader.
Scalpers
This is probably the hardest one you can pick. Why?
Scalpers are in and out of the markets very quickly; their trades last from minutes to
sometimes just a few seconds. Because of that, you are required to focus 100% during the
whole trading session. Scalpers also miss a lot of trading opportunities and rely solely on
the big winner they are able to catch once in a while. This is something that can be very
demanding on your psychology as you lose a lot and no one likes losing. So why do people
choose to be scalpers if it is so hard?
There are two major reasons for that.
The first one is the returns. Being in and out of the market means you are getting many
opportunities in the market every day. Swing traders, for example, have to wait several
days for the right opportunity and they quite often sit at their hands and wait.
Scalpers do the exact opposite. Even though their win rate is usually lower, they can easily
compensate for it with the reward to risk ratio and the number of opportunities they get.
The second reason, which is not often talked about, is freedom. Scalpers and day traders,
whom we are going to talk about next, don’t really care about long term movements in the
market. Because of that, they trade during their currently active session, which can be 4, 8,
or 10 hours long. Once they are done, they don’t have to care about the market until their
next trading session. This reduces the stress of babysitting any long-term positions which
could disrupt your sleep and generally stress you out.
Day traders
Day traders are similar to scalpers in a lot of things.
They also watch markets in their predetermined sessions, but usually, they want to watch
the market the whole day. They are not interested in quickly being in and out of the trades,
but they much rather capture a bigger intraday move. For that reason, they only open a
handful of positions, yet sometimes they even stay flat for a whole day. Although day
traders are required to watch the market for longer, the approach tends to be more relaxed
with high focus only required when the market trades around their desired level.
Day traders usually hold trades for a few hours. As they try to capture the bigger moves,
they know they have to give the market room to breathe. They generally do not hold
positions overnight, but sometimes they do as they try to capture even bigger intra-week
moves.
Swing traders
Swing traders are looking to capture intra-week moves. They hold positions for a couple of
days, sometimes weeks. Swing trading is very popular among beginner traders because it
doesn’t require much chart time and analysis. You can prepare for your trades in the
morning and thanks to alerts and limit orders, you let the market do its thing with very low
input.
This sounds like a piece of cake, right? Are there any downfalls?
Yes, there are. Swing trading requires an extreme amount of patience as you often have to
wait for several days for the market to give you your desired setup. And the real work
begins once you enter the position. Because you are holding the position for a longer time,
you must be ready for swings in price and sometimes disrupted sleep. Also, since you are
taking fewer trades, building your track record will take much longer.
Position traders
You will hardly become a position trader early in your trading career. Position traders are
also called investors. They hold their trades for weeks, months, or years and they usually
follow large fundamental sentiments. A big amount of capital is required to become a
position trader.
Broker
A brokerage firm is a legal entity that provides its customers with access to the capital
market, thus acting as a necessary third party for buying and selling securities. It facilitates
secure transactions on behalf of its customer, who executes their own trades on his/her
trading account.
A Forex broker is a company registered in the commercial register dealing with the
mediation of access to trading on financial markets, especially in forex. The broker
company generates profits by charging spreads and trading commissions.
Forex broker provides its customers with the trading platform (software for access to
financial markets), monitors current market events, issues, and opinions, and
communicates ideas for trading in the form of comments, fundamental or technical
analysis, etc.
When choosing a forex broker, paying attention to market capitalization, company history,
number of active clients, registration, license, and security of finances is recommended.
Limit/Market orders
When you place a market order, you are going to get filled immediately at the best available
price. One of the biggest problems with market orders is the risk of slippage during highimpact news and the fact that you always pay the spread.
On the other hand, the limit order says that you only want to get in the market at one
desired price and nothing else. Limit orders are considered a patient approach, their
disadvantage is the fact that traders might get too patient and miss their desired fill.
Stop Loss/Take Profit
Stop Loss and Take Profit are very straightforward. Stop Loss gets traders out of a trade
when it goes against them. Traders place Stop Losses at various technical levels or fixedpoint values. Using a Stop Loss prevents traders from unexpected spikes in price, which
could result in significant losses.
Take Profit is in the same order as Stop Loss but on the opposite side. Take Profit gets
traders out of a winning trade at a predetermined price.
Reward to risk ratio – RRR
The reward to risk ratio is very simple. It is how much you risk compared to how much you
can gain.
If you risk $100 to gain $300, your reward to risk ratio is three to one. If you are risking
$100 and you have a fixed $100 reward, you need to be right over 50% of the time to be
profitable. With two to one reward to risk ratio, you only need to be right 40% of times to
make money. The higher reward to risk ratio you have, less the percentage strike rate you
need to be a profitable trader.
The equity simulator on our website is a great tool you can use to show the expectancy of
your trading based on strike rate and reward to risk ratio.
Trading sessions
There are three major trading sessions in trading forex:
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Asian
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European
 North American
All of these sessions provide opportunities in the different markets as the volume changes
throughout the day. If you are trading an Asian session, trading a pair like EURGBP doesn’t
make much sense. But looking at AUDJPY should bring great trading opportunities.
The European and North American sessions have the highest volume, and markets are
moving across the board in these sessions.
CFD – Contracts For Difference
Table of Contents
 What is a contract for difference (CFD)?
 History and pros/cons of CFDs
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Long term holdings of CFDs
The main reasons to trade CFDs
CFD vs Futures
o How about commissions?
What is a contract for difference (CFD)?
CFD is an agreement between the buyer and the seller, which obliges the seller to pay the
buyer a difference between the asset’s current value and the asset’s value at the time of
contract closure. If the buyer went long and the difference in price is negative, then the
buyer pays the seller and vice versa. CFDs are financial derivatives that allow us to
speculate on the price development of the underlying asset without the need to own the
underlying asset. It is a so-called derivative that covers a wide variety of financial
instruments traded on both stock exchanges and OTC markets around the world. The term
“financial derivative” is based on the meaning of the English word “derive”. It is, therefore,
a kind of derivative of a particular asset. In our case, it is a derivative of the selected
financial instrument traded on one of the world exchanges. We also call this financial
instrument an underlying asset, which can be a stock, index, commodity, currency pair,
cryptocurrency, etc. The price of derivatives is fully dependent on the price of the
underlying asset.
History and pros/cons of CFDs
For CFDs, it is 1990 when the first derivative was created by the famous London broker
Smith New Court. It was a financial product that bore all the benefits of trading stocks
without the need for their physical possession while minimizing their disadvantages.
Compared to shares, it was several times cheaper and allowed to take short positions
without the need for the previous borrowing of shares. At the end of 1990, a company
called GNI was allowed to trade CFD contracts directly on the London Stock Exchange by
forwarding instructions over the Internet.
CFD trading is very popular and is offered by many brokerage companies. CFDs are traded
to profit from price differences between sales and purchases. CFDs are, therefore, among
the financial derivatives that are always linked to their subject underlying financial asset.
The specific type of underlying asset is levied by each intermediary company (brokers,
banks, etc.) according to its capabilities. This is often the currency pair, stocks, equity
indices, commodities, bonds, interest rates, etc., traded on a world exchange.
The main con is that there are no standard contract terms for CFDs, each provider can use
its own, but the substantial part usually remains unchanged. Lack of regulation is the main
reason why CFD trading is banned in the United States.
However, as we are not a broker, even traders from the US can trade CFDs with FTMO. CFD
thus constitutes a contractual arrangement between the seller’s party and the buyer’s
party, as we already mentioned.
Long term holdings of CFDs
Holding open CFDs for a longer period is possible, but it should be remembered that even
though CFDs do not expire, the trader can be charged swaps for overnight holding. The size
of a swap is based on the interest rates of central banks of the countries whose currencies
we trade. The larger the difference in rates, the larger the swap. A swap is positive when a
long position is held in the currency with the higher interest rate, while it is negative when
the trader is in a short position on the currency with the higher interest rate. Thus, a swap
differs for different currency pairs. Its size also depends on the broker (liquidity provider).
The norm is that swap charging place at 10 PM British time, but this differs from broker to
broker, and it is always necessary to verify the specific terms of your account.
The main reasons to trade CFDs
CFDs are available with many brokers who also provide classic investment products. Since
you have never owned an underlying asset for CFD contracts, you can trade markets that
are otherwise non-negotiable for a retail trader, such as indexes. With CFD contracts, you
can benefit from a rising price and the price declines. Most stock CFDs can also be shorted,
and you don’t need to borrow stocks as you normally would for traditional investments.
CFD trading can be made extremely fast. It depends on the broker’s execution time. You
should know that a good trading platform has a live market data feed, and various
automated trading systems can work their logic on these data changes immediately.
CFD contracts are traded with leverage, so you don’t need high initial capital to speculate
on short-term volatility fluctuations. This means that you only need a fraction of the
position value to open the order, and you can use some of your capital for other purposes,
such as scalping other CFDs. However, you should remember that while leverage reduces
the margin needed to open a trade, profits, if any, may be significantly higher than when
trading without leverage. Obviously, the same applies to losses too. You should also
remember that even if you do not physically buy the underlying asset, you are exposed to
the underlying markets, and there are different risks involved.
CFD vs Futures
Let’s say that we want to trade the very popular German DAX on futures markets. Due to
the large volatility, the intra-day margin is around €13,000 per contract (dates from 2018).
The intra-day margin is the reserve deposit on the account for opening the trade. If we hold
the position overnight, the margin reaches far beyond €21,000.
How about commissions?
The commissions for trading CFDs used to be greater than on Futures, but today the
situation is unclear. For example, FTMO clients can access CFD contracts on stock indices,
crypto or futures with zero commission. However, the truth is that trading Futures is still
much more difficult financially because of paying for the data feed and platforms.
It is important to consider that most retail traders don’t have €21,000 to spare for trading
DAX from the beginning. This is where the best advantage of CFD comes in place instead of
the futures. Dividing the positions enables us to trade DAX with much smaller capital
requirements. From the risk-taking perspective, having the possibility to trade DAX
through CFD is yet more significant.
In the last column of the table above, we can see the DAX position sized 0.2 lots traded
through CFD. The beauty of CFDs is in the possibility of working with multi-contracts while
having a small capital. If we were to trade the highest position of 0.2 lots while having two
different profit targets, CFD would allow us to enter twice by 0.1 lots each and set the
required parameters separately.
Finally, it’s important to mention that trading the futures indexes through CFDs isn’t
suitable for all markets and this is due to the associated costs. This is predominantly for
short-term traders who target smaller profits. Talking about the DAX index, the ratio
between the spread and the daily range is actually very good. This makes DAX an ideal
market to be traded through the CFD. Other optimal markets for day trading CFDs would be
Nasdaq or gold.