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PTMC team 07.12 2014

World markets in Protrader

Hey there, Protraders!

With the development of informational technologies, Internet trading has become available to everyone who has a computer and internet connection. Moreover, the presence of the computer is also not a necessary condition; in some cases it is sufficient to have a smartphone. Brokers offer for each individual trader the possibility to check their own strengths to trade by hundreds of assets. In such a huge variety of opportunities it is hard for beginner to make a choice in favor of some trading instrument or instrument group. In today’s article I would like to give a classification of the most popular trading instruments and to consider the trading characteristics of each of them. Under the trading instruments we’ll further understand the different types of securities, currencies and derivatives.

The market can be organized (when the turnover of securities is performed by the established regulations and laws with the help of licensed intermediaries) or unorganized (when the relationship between the buyer and seller is regulated only by their personal agreements). Of course, the organized market is more preferred, as it has the specialized supervisory authorities over the legality of the market activity and the probability of fraud is very low.

The markets can be divided by type of organization the trading on exchange and OTC (over-the-counter) markets.

Exchange market is organized centrally on the base of legal entity - the exchange. The exchange regulates the prices of assets, monitors the execution of obligations by trading participants, and resolves possible disputes. Trading on the exchange is performed in the strict correspondence with developed regulations and rules. The exchange contracts which parameters are strictly regulated by the specifications are subject of the trading. The exchange collects and publishes data about made trades that gives an opportunity to assess the dynamics of trading interest to a particular asset.

OTC market. All trades on securities or other assets that are held not on the centralized exchange are referred to the OTC market. Trading on the OTC market is performed with the help of dealer network who act as organizers of the trading. They are quoting trading instruments, defining the prices to buy and to sell the assets. Herewith, trades can be made both with clients of the dealers as well as with other dealers. In this case, the prices for the same asset are not required to be the same for all customers. OTC market doesn't have a centralized structure, but often it is organized not worse than exchange market. But due to the decentralization, the OTC market is not as transparent as the exchange market, for example, to receive the exact information about trade volumes by instrument of interest is almost impossible.

The markets can be divided by type of made trades on spot and derivatives markets.

The spot market is characterized by immediate payment and delivery of the traded asset.

The derivatives market implies the trading of contracts on the delivery of the assets in the future. In this case, the terms of delivery are negotiated by the contract between buyer and seller. The derivatives market can be both exchange and OTC.

The markets can be divided by type of the traded assets on markets of commodities, currencies, securities and derivatives.

Trade assets on markets of commodities, currencies, securities and derivatives.

Commodity market. This is the market where the corresponding commodities or groups of commodities are traded. For example, metals, utilities and agricultural commodities.

Currency market. The market where the buy/sell trades are held to different currencies.

Securities market or stock market. The market where the securities (equities, bonds, etc.) are traded.

Derivatives market. The market where the buy/sell trades are held to the derivatives of financial instruments, such as Options, Swaps and Futures are performed.

Let’s consider the features of the trading by different instruments.

Equities and bonds.

  • The limited time of the trading. The trading is accessible only in the trade session. Trade session is directly connected with geographical location of the exchange on which the selected securities are traded. The start time of the trading and its ending are strictly defined.Trade session usually has several phases, active trading is often observed in the first few hours after the market opening and before its closing. At the lunchtime the activity of the trading is reduced. It is related to the work cycles of the market participants. The increase of the position occurs at the beginning of the day, at the end of the day the massive exit from the market occurs that can provoke the growth of volatility.
  • Huge number of equities. The large number of equities is traded on the stock market; all of them differ primarily by their liquidity. It is better not to use the equities with low liquidity in your trading. The price dynamics of such securities has a high degree of uncertainty. Also due to low liquidity the losses on the slippages are increased when opening and closing the positions.
  • Non-recurrent significant changes of the equity price are possible. For example, as a result of the procedure of stock split that hampers the correct testing of the trading systems and can result in losses.
  • The stock prices significantly depend on the economic news affecting the corresponding economic sector. Since the traders who use the change of the basic economic indicators as the signals, constitute a significant portion from all equity market participants, the appearance of certain news can provoke a massive opening or closing of the positions that will lead to the short-term strong growth of the volatility. Consequently, in the anticipation of the important economic news it is worth to close the position or toughly limit the size of the possible loss.
  • The rumors of the new technologies, discoveries, mergers of the companies can groundlessly change the stock price. Even having a clear understanding of the prospects for the selected paper, for example, after the thorough analysis of the company reporting, the loss can be obtained due to growth of the volatility on hearsay. It is appropriate to recall the adage: "Buy the rumors, sell the facts.”
  • The most important factor in the trading for equities is the analysis of the periodic reporting of the companies. Based on these reports we can obtain the assessment of the real company cost and its capabilities to pay the dividends from the main economic indicators. Knowing the "fair" cost of the paper, naturally, would be profitable to trade on the deviation of the real price from your forecast. All depends on the quality of the analysis.
  • For certain types of the strategies it is worth to choose only equities that have shown the high volatility over the past few days or have updated the maximum historical values. In this case, the equities will get into the “Watchlist” of a large number of traders, which in turn, under certain conditions can provoke further growth of the stock.
  • Investing in the bonds of the reliable issuer has lower risks than speculative trading of other asset types. If you purchase, for example the government bonds, the main risk factor which can lead to loss of invested funds is the risk of default of the state, but this event is unlikely. As a result the profitability of the bonds that is slightly below the level of bank deposits is compensated by the high security of such investments.
  • Some types of the bonds give an opportunity to receive the periodic payments in addition to the cost of the bond at the end of the maturity date.
  • The volatility of the bonds basically is lower than other trading instruments have.

Futures and Options contracts. Futures and Options have many features connected with underlier.

  • You should take into account the type of Futures (Physical delivery or Cash-settled) or Option contract (American or European).Due to ignorance of features of the traded futures contract, we can encounter with the problems related to unnecessary delivery of the physical asset. If the strategy provides an early performance of the option or the possibility of this event should be excluded, it is worth paying attention to the type of used option contract. American option, unlike European, can be executed at any time during the life of the option.
  • Margin requirements for the intraday trading can strongly differ from the margin requirements when transferring positions through the night. Also, the margin requirements can be significantly changed for the period of the contract existence that requires the availability of the significant protective capital. For example, having the correct prediction of the future asset movement, the loss can be received only due to lack of the funds to maintain an opened position.
  • The accounting for the specifics of the underlier. For example, trading with futures or options contracts on agricultural products, we must take into consideration the peculiarities of the commodity production cycle, seasonality, the relation with adjacent and interchangeable assets, changes of the weather and economic policies regarding the export and import of this product.
  • It is important to know the specification of the traded asset contracts, time of the trading, trading peculiarities in the different sessions and procedures of the expiration. Thus, trading with option contracts, you need to know what will happen after the expiration of the option. This will protect from possible unforeseen risks.
  • The existence of the trading limits. The exchange specifies the trading limits for each instrument; this is the limit values of the price change for a certain period on reaching which the trading is stopped.
  • When trading using options contracts it is important to understand the option price formation and the factors which can significantly change the price of the option contract. The situation of obtaining the substantial "paper" loss is quite probable, even during the underlier movement to the side of opened position. Knowledge of the strengths and weaknesses of the option position will provide an opportunity to prepare a plan of actions in the case of the negative scenario and thereby to control the possible risks.

Before starting a trading activity on a particular asset, the trader must carefully examine the features of trading on the selected market (the timeframes, rules of making the trades, trading mechanism, rules of delivery, payments, etc.). Sincethe ignorance of the trading features of the selected instrument can lead to the loss of funds.On the other hand the understanding of the trading process, the tasks and objectives of the participants, limitations of separate traders’ groups in certain situations can help in building a profitable trading system. Let’s give the simple example. While trading for whatever reasons the deliverable Futures on the beef without closing the long contract in the required time, you can become the proud owner of 40,000 pounds of beef, while receiving in addition the costs on transportation and storage of meat.

The methods both of technical and fundamental analysis work well enough on all of the above assets. The success of these methods depends on how well they describe or anticipate the actions of different traders’ groups in certain situations. In turn, for understanding of the trading participants’ actions, the trader must know the structure of the participants on the selected asset and understand the goals they pursue. Based on an understanding of the features of the selected asset we can significantly improve the performance of our trading system


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