What is trading and how does it work?

What is trading?

Trading is the buying and selling of financial instruments in order to make a profit. These instruments range from a variety of assets that are assigned a financial value that goes up and down – and you can trade on the direction they take.

You may have heard about stocks, shares and funds. But there are thousands of financial markets you can trade, and a variety of products you can use to trade them.

You can get exposure to markets as diverse as the ADX, S&P 500, the FTSE 100, global currencies like the US dollar or Japanese yen, or even commodities like lean hog or cattle.

To get started, you’d need to create an account on a platform that offers these markets. Our online trading platform has a variety of financial markets that enable you to speculate whether the price of an asset will rise or fall via CFDs. Plus, we’ve compiled a trading for beginner’s guide to assist you in getting familiar with the different markets.

Trading vs investing

The difference between trading and investing lies in the means of making a profit and whether you take ownership of the asset. Traders make profit from buying low and selling high (going long) or selling high and buying low (going short), usually over the short or medium term.

Investors aim to buy stock at a favourable price and take outright ownership of the stock. They make profit from holding the stock and selling it at a higher premium. The hope is that the stock price changes over the long-term and they can profit from the movement. Investors could also earn income in the form of dividends if the company grants them. Plus, they’ll have stockholder voting rights.

It is also important to note that trading on derivatives like CFDs come with a high risk of losing money rapidly due to leverage.

Who trades and who invests?

Traders, as opposed to investors, are those who’d prefer to make use of leverage and derivatives to go long or short on a range of markets.

Individuals (called retail traders), institutions and governments trade. They participate in financial markets by buying and selling assets with the aim of making a profit.

Some financial traders stick to a particular instrument or asset class, while others have more diverse portfolios. Governments and institutions can adapt at a much faster pace, as they often have departments that focus on trading different sectors and industries. Institutions remain the biggest participants in the market, with 77% of trades attributed to them.

For individuals to invest on the stock exchange, they must go through a stockbroker that will execute the order. They’ll do their due diligence, research before placing a trade, read charts, study trends, and the broker will act on their behalf. They trade from their own private accounts, which they fund and bear the full risk of losing their capital.

Institutions that trade include commercial banks, hedge funds, and corporations that have an influence on the liquidity and volatility of stocks in the market. This is because they typically engage in block trades, which comprises of buying or selling at least 10,000 shares or more at a time.

These entities stand to profit from supply and demand of goods or products, political instability, the availability of currency (including the movement of interest rates), and many other factors.

How does trading work?

When you trade, you profit if the market price of your position moves in the right direction, and you lose money if the price of your position moves in the wrong direction.

The basic premise to remember is supply and demand. When there are more buyers than sellers in the market, demand is greater, and the price goes up.

If there are more sellers than buyers in the market, demand is reduced, and the price goes down.

Getting exposure to assets can only be carried out over the counter (OTC) or directly on an exchange.

Trading OTC involves two parties (trader and broker) reaching an agreement on the price to buy and sell an asset. Whereas an exchange is a highly organised marketplace where you can trade a specific type of instrument directly. For example, you can trade Emirati stocks on the Abu Dhabi Securities Exchange (ADX).

As you’ll come to realise, most retail traders in the UAE trade OTC, using derivatives like CFDs, because the stocks are more accessible than those listed on a centralised exchange.

You can also trade futures, which give you the right to buy or sell the underlying asset at a predetermined price by a certain date, before the contract’s expiry. Futures have higher spreads but no overnight fees and are often favoured by medium- to long-term traders.

Some traders prefer options over futures, because buying them has limited risk but selling them carries the risk of potentially unlimited losses.