Find the right product

Share dealing

This activity might be what you think of when the stock market first comes to mind. Share dealing refers to buying ownership in listed companies directly.

If you choose to use share dealing to build your wealth, you’ll be the beneficial owner of the assets you buy. It also means you’re eligible to receive dividends associated with the investment.

They’re issued at the discretion of the company, so the company could choose to cease paying dividends. Some companies use their profits to buy back their own shares or invest them in new acquisitions instead.

When markets are down, even the best-performing shares in the world can come under pressure and decrease in value. However, quality shares can recover over time and might reward patient investors.

Share dealing enables you to build your own diverse portfolio, buying stocks in companies that you think will increase in value over time. If you decide a share isn’t doing as well as you’d hoped, you can sell it and look for a better option.

Unlike other trading products, investment accounts typically charge low or even no fees to hold your shares. That’s good news, because when you find a winning share, you might hold on to it for as long as you can. Most providers will, however, charge a commission when you buy and sell shares.

Managed portfolios

These offer an alternative to buying individual shares. They’re often managed by a broker and the legwork of selecting shares and putting together a diversified portfolio is usually done for you.

Managed portfolios can be structured according to your risk profile, so you can look for one that suits you. Usually, bonds and commodities are also included in them, which can further diversify your portfolio.

Because they’re non-leveraged, you may assume that they only suit those who are more risk averse. However, managed portfolios can include riskier investments which increases the inherent liability.

These might be a solid entry point into the market as they offer both immediate diversification and expert management, all in one simple product.

Exchange-traded funds (ETFs)

Exchange-traded funds (ETFs) track a collection of shares, such as an index, or even different assets, like stocks and bonds. They’re a relatively simple way to get exposure to a range of shares.

You buy them as you would a share in your share dealing account and they may also be included in some managed portfolios.

Diverse and low-cost, they’re another path you could choose when starting your investment journey.

They’re a time saver as you won’t need to research individual shares. Instead, you can select an ETF with a theme, such as global shares. You won’t have to worry about monitoring the different shares within it.

Exchange-traded commodities (ETCs)

Exchange-traded commodities (ETCs) are similar to ETFs but, instead of shares or indices, they have commodities as the underlying asset.

It could be a single type of commodity or a diverse index of commodities around a theme, like agriculture. The latter might include a number of different agricultural products in one ETC, like barley, corn and milk.

Trading and leveraged products

Once you start taking on leverage, you’re venturing into the realm of trading rather than investing.

As you’ll have learned, shares can be bought without leverage and may be used as a long-term investment. Using leverage on the same shares would be more about their short-term price changes instead of their long-term growth potential.

Leverage helps you get greater market exposure with a relatively small initial outlay. The increased risk comes from the potential amplified profits or losses.

Many financial instruments have leverage built in and can be used on most underlying markets such as shares, commodities, forex and indices. Instead of just buying an asset outright, you’d select a leveraged position, immediately increasing the risk and the reward of the trade.

Leveraged derivatives are usually used by short-term traders who hope to profit from a market moving up or down.

Contracts for difference (CFD)

CFD trading is one way you can take a position on the price changes of an asset. Instead of owning the asset itself, you’re trading based on the price movements of that underlying market.

They also use leverage, but they’re relatively simple to understand. CFDs enable you to go long or short on any asset class.

The price at which you enter a CFD position is based on the value of the underlying asset. As it’s a leveraged trade, you only pay a portion of the actual cost of trading the asset to enter the market. The leverage used adds extra risk as both profits and losses can be magnified. Let’s see how this works.

Say you want to trade a particular share, which is valued at £2.45. You open a trade by buying 1000 CFDs. The total value of your position would be £2450, and you’d be required to pay a 10% margin (or £245). That gives you 10x leverage, which is ten times the exposure to the market.

Spread betting

Spread betting is another way you can make a prediction on the financial markets and place a bet on its price movements. To use these derivatives, you’ll need to pay a small deposit to open a larger position and get greater exposure.

The cost of your trade is included in the spread. This is the difference between the buy and sell prices of an asset – the buy price is higher than the market price and the sell price is lower.

You don’t own the underlying asset you’re trading. In this instance, you can take a position based on whether you think the market price will rise or fall.

The more the market moves in the direction you’ve placed your bet on, the more profit you’ll make. The inverse is also true, and your losses increase with every move in the opposite direction.

These products may have either daily, monthly or quarterly expiry dates, but you can close your position before it reaches it. If you’d like to keep the trade open for longer, that can be arranged.

Let’s use the same example as before to illustrate how a spread bet would differ from a CFD trade.

Options

These financial instruments are slightly more complex than CFDs and spread bets because of how they’re structured.

Options are contracts that give you the right, but not the obligation, to buy or sell an asset on or before an agreed date (strike date), at an agreed-upon price (strike price). You’ll pay something called a premium to buy an option, but the trade will only be executed if you exercise your option.

There are two main types of options: vanilla and barrier.

Vanilla options

Let’s start off simple. You’d use call options if you think that a market will rise, while put options enable you to take a position on a falling market. Because you’re not obliged to execute your trade, you can allow your option to expire if the market moves against you.

Leverage is built into the option’s price, but that’s not the only thing you’ll need to consider. Options are complex in that they have strike prices and dates. The formula for determining their value uses variables like sensitivity to volatility or the effect of changes in interest rates.

Barrier options

These have an extra layer of complexity: you select a level at which the option comes into effect. Your total risk essentially becomes a stop loss for your trade. Barrier options move one-for-one with the underlying asset. This means if the price of the underlying asset changes, so does the price of your option.

You could also use a put option as a hedging strategy if you’re concerned that markets may be falling. Rather than selling your local investments, buying a put option on an index like the FTSE 100 might help provide a layer of protection to your overall portfolio.

If the market falls, your share portfolio would be worth less, but you could make a profit on the put option, reducing your overall loss.

Want to learn more? Take our complete course on options here.

Spot

Spot trading is offered on forex, indices, ETFs, shares and commodities. It entails paying the current market price on whatever asset you’re trading.

A spot market can refer to both a physical underlying asset and a derivative instrument. The biggest difference is that with leveraged products, you’re not taking delivery of the underlying asset, you’re just trading on its price movements.

If you think an index will be rising in the weeks ahead, you’d be able to buy a position on it using the spot price, with added leverage that enhances the potential risk and reward of the trade.
In many ways, spot trading is trading at its most basic form, but leverage adds an element of complexity. It has no expiry, so you can remain in the trade for as long as you want without having to worry about a looming expiry.

Futures

Futures contracts are agreements between a buyer and a seller to trade an asset at a set price on an agreed-upon date in the future. Unlike with options, there’s an obligation to complete the trade.

Further, your loss isn’t capped, and you can lose more capital than you have in your account. Say you anticipate that the price of the FTSE 100 may rise in the next three months. You take out a futures contract so that on a particular date in the future, you can buy the market at a lower price than you think it’ll be.

If the underlying market moves against you instead and the price falls, the set price you agreed to pay will now mean you make a loss. Because of the obligation to complete the trade, you’ll need to have enough money in your account to cover that losing position.

Futures also use leverage, but the cost is built into them and subtracted from the trading price every day.

You can trade them on several markets, including shares, indices, bonds and commodities.

If you’re trading on the market itself, you’ll take delivery of the asset. However, this only happens at expiry. You can avoid this if you sell the contract before then.

You can also trade CFDs or spread bets to trade futures contracts, meaning you’ll never physically own the underlying asset.

Exchange-traded products (ETPs)

There’s a wide range of exchange-traded products (ETPs) available to trade, depending on where you reside. While ETCs and ETFs also fall into this category, they’re often used as part of long-term investments.

Some ETPs, like the ones we’re about to discuss, are more sophisticated than others, and can be better suited to traders, not investors. This is because they’re designed to help you seize opportunities in the short-term moves in an underlying asset.

These products can give you exposure to a range of assets, including shares, indices, forex, commodities and even cryptocurrencies.

Let’s see how they work and what makes them different to over-the-counter (OTC) trading products like CFDs.

Turbo warrants

Turbo warrants, or turbos, are leveraged securities. You can use them to go long or short on a market and their price tracks the underlying asset one-for-one.

For each turbo trade, you select a knock-out level that controls your maximum risk. This level indicates the point where you’ll exit the trade if the market moves against you. Your initial outlay also acts as your maximum possible loss.

There are two types of turbo warrants: long and short. You’d buy a long turbo if you expect an underlying market’s price to rise and if it does, you’d make a profit.

Short turbos are best suited for when you expect the price of the underlying asset to fall. If it does, the short turbo’s price will rise in value.

These instruments include leverage, but the amount you take on is based on where you set your knock-out level. The closer it is to the current underlying asset price, the higher the leverage.

They can also be a great tool for traders looking for a leveraged trading product with downside protection.

Covered warrants

These leveraged products give you the right, but not the obligation, to buy or sell an underlying asset at your chosen price (strike price) sometime in the future. They’re similar to options because you pay a premium. The difference is that your risk is limited to that initial outlay.

If you’d like to take a long position, you’d buy the underlying market with a call warrant. In this instance, you think that the market price might rise beyond your strike price. If it does, you can exercise your right to buy the underlying for less than the current market price.

If you’re planning to sell the underlying instead, you’d use a put warrant, essentially taking a short position. Here, you can make a prediction on falling markets and try to make a profit by selling the underlying for more than the current market price.

Let’s try a working example. Say you’ve been monitoring the share price for ABC plc, which is currently £110 per share. You think that it’ll rise in the next four weeks, so you decide to purchase a call warrant for £10, with a strike price of £100.

If you were right and the share price increases to £150, you can exercise your right to buy and make a profit of £40. Because you’re trading a leveraged derivative, you won’t need to own the share itself to make money.

Had you been wrong, and the share price for ABC plc dropped to £50, you’d only lose your initial outlay of £10 because of the built-in risk protection of this product.

The combination of limited risk and leverage mean that you’re able to increase your exposure to the underlying market and magnify potential profit while preventing amplified losses.

Constant leverage certificates

A constant leverage certificate (CLC) is another ETP that helps traders limit their risk. These products can give you exposure to assets like shares, commodities or forex.

While they’re designed for traders, they can also be used by long-term investors with lower levels of leverage. This is because when you purchase a CLC, you can decide on the leverage that suits your risk profile.

They also have no expiry date, but if you hold them for longer than a day, their performance can start to differ from that of the underlying. This is because the leverage compounds at the end of the day.

Your potential profits will be amplified, but so will any losses. These are calculated by multiplying the underlying’s daily performance with the leverage factor you select.

Like covered warrants, these products limit your risk so that you never lose more money than you initially put in.

Let’s look at a working example. Say you decide to go long on ABC plc and buy a x5 CLC for £20. The leverage allows you to take a position worth £100. If the underlying price increases by 20% and closes at £120 at the end of the day, your profit will be £20 (a 100% return).

If the underlying market gained another 20% with the same x5 certificate the next day, it would close at £144. Your profit would now be £44.

The compounding effect that we’ve seen here will continue for as long as your position remains open. This means that at the start of each trading day, your leverage level (x5) will be applied to the new value of your total position.

However, the same compounding applies to any losses. After day one, if the underlying price had dropped by 20%, it would close at £80. The market moved past your initial outlay, so you'll be knocked out of the trade.

Remember, both your profits and losses will also be affected, so you may need to monitor any long-term positions.

Choosing the right product combination

As you can see, there are lots of different products that can help you access the financial markets. We’ve covered in our previous lessons how you can use your risk profile and time horizon to help you choose which ones are right for you.

You might also consider leverage and how well you understand each product to aid in your decision making. Remember though, you can have multiple financial goals you want to achieve. Therefore, you could follow a multi-product strategy, which we’ll cover in the final lesson.