Financial Markets make an economic system where the participants trade in certain products (financial instruments). The system consists of the following participants: banks (which may act as market-makers), stock exchanges, brokerage companies, financial institutions (e.g., funds), and individual traders. The products in which financial market participants trade are called “financial instruments” or “assets”.
In a general way, financial instruments mean certain commitments (contracts) confirming the fact of two parties’ mutual claims. One party undertakes to deliver (immediately or in the future, unconditionally or under certain conditions) a certain product, and the other agrees to pay in a certain way (for example, by money or securities).
An important feature of financial markets is that money or securities may be treated as a product too. Of course, ordinary products and raw materials are also traded in financial markets. So, financial markets can be divided into a) currency, b) stock and c) commodity markets.
Figure 1. Types of financial markets
In this course we will concentrate on the Forex market and its participants, such as brokerage companies and individual traders. The roles and functions of other market participants (banks, stock exchanges, financial institutions) are well described in many sources (ref. List of recommended literature), as well as in the company ‘s specialized courses.
Another feature of the financial markets consists in standardizing the volume of transactions (contract size) by introducing the idea of lots. On the Forex market, a standard contract (one lot) amounts to 1,000,000 (one million) units of a purchased currency. Actually, such volumes are traded extremely rarely at Forex. A more typical situation is when a transaction has a volume of ten (10,000,000 units) or more lots.
This volume of transactions is not always available to an individual investor. Companies engaged in brokerage services in the Forex market (e.g., LiteForex), provide private traders an opportunity to carry out transactions in the Forex currency market through so-called credit leverage. It occurs as follows: a trader pays a deposit in his/her account with the company (sometimes referred to as “security deposit”), which is then used as security margin and serves as a guarantee of the client’s solvency. When the client opens a trade, a part of the margin gets frozen.
In its turn, a brokerage company adds funds and thus increases the trade amount 50, 100, 200 or 500 times. In essence, this is a target credit provided to the client by the brokerage company for as long as the transaction is opened. Some companies provide leverage at interest or charge a commission, but the LiteForex Company provides leverage at no cost. The leverage size is indicated as “1:50”, “1:100”, “1:200” or “1:500”. The use of credit leverage (or financial leverage) allows an individual trader to enter the Forex market with a relatively small deposit. Thus, if a trader has USD 10,000, then the maximum amount of the transaction he can afford is estimated at USD 1,000,000 (one million US dollars) when using a leverage of 1:100.
Figure 2. Credit leverage use
Besides credit leverage, brokerage companies provide an opportunity to trade on cent accounts and work with fractional lots. In this case, an individual trader is able to work with deposits starting from as little as 1 US dollar. It will make 100 units on a cent account, and, with credit leverage applied, a trader will be able to open a transaction of 10, 000 units (0.1 lots). Transactions with a volume of 10,000 units or less are called fractional (mini and micro) lots. A brokerage company cannot process those micro-trades separately; therefore an aggregate position is submitted into the market when operating cent accounts.