This article will discuss the most common instrument for trading.

What is ‘instrument for trading’ ? For example: a car dealer buys cars from car company and sells to retail customer at  higher price for their profit. Hence the instrument for this trading is car. So, “instrument” is just something that will be sold our bought during the trading activity.

The most common instrument in today’s financial market will include:

Some trading Instruments

1. Stock / Share
   ‘Stock’ or ‘Share’ is a piece of a company. If a company has issued a total of 10,000 shares, then if you own 1000 shares, you own 10% of that company. If the company is very profitable and growing very strong, then the value of the company will go up, therefore the share or stock of the company will go higher in price as well.

   Of course, there are also other external factors that will contribute the price movement, for example: market sentiment, economic condition, extraordinary event, announcement, etc.For public company, you can buy and sell a stock via the stock-exchange.

   Read “How Stock/Share Produces Profit for Trader” for more detail.

2. Bond
   ‘Bond’ is certificate of a debt. For example: If you buy a bond from government, basically you lend your money to government for certain period of time. In return the government will pay interest regularly and at the end of the period will return the total amount. If the interest rate is going down, the value of the bond  will go up, if the interest rate is going up, the value of the bond go down.

   A company can also issue a bond to borrow money from public. But when we are talking about bond, most of the time it will refer to government bond.

   Read “How Bond Produces Profit for Trader” (to be released) for more detail.

3. Derivative
   “Derivative” is basically a financial contract over an asset. So the one being traded is not the asset itself, but a contract related to the asset.
   1. Option
      Option is a contract that give the buyer a right to buy an asset (this option named “Call Option”) -or- the right to sell an asset (this option named “put option”) at certain price (called ’strike price’). It’s a right but not obligation. The right will cease after certain period (usually a few months).
      General public and buy and sell option via the stock exchange.

      Read “How Option Produces Profit for Trader” for more detail.

   2. CFD (Contract For Difference) - Not available inside US
      CFD is a contract between trader and CFD provider to buy or sell a stock and only pay as low as 5% of the price as collateral or margin. The rest of the price will be covered by the CFD provider in a form of lending and the trader will need to pay some interest.

      For example: Microsoft share is at $25. to buy 10,000 share will require $250,000. But with CFD, we only need as low as $12,500 to buy 10,000 contract (1 contract=1 share). With 6.5% p.a interest rate, the trader need to pay 6.5% x $250,000 = $16,250 p.a or $1,354 monthly.

      If within 3 months the share increase by $4, then the profit will be $4 x 10,000 share = $40,000. The interest cost is 3months x $1354 = $4062. Net profit = $35,938. The total capital required is $12,500 (margin) + $4062 interest = $16,562. Hence the proceed is $35,938/$16,562=217% gain.

      The comparable product for US Citizen is what is called “Portfolio Margining” where just by buying the put option, the lender will lend 100% of the value of the stock.

      Read “How CFD Produces Profit for Trader” (to be released) for more detail.

   3. Warrant, LEAPS , LEPO
      Warrant is similar to option, only the maturity date is very long (up to 5 years) and the one can issue a warrant is only a company or a bank.

      LEAPS (Long-Term Equity Anticipations Securities) and LEPO (Low Exercise Price Option) is a variation of options:
      LEAPS: the period is very long (up to 2-3 years – similar to warrant)
      LEPO: similar to call option with very low strike price (e.g: 1 cent) and both the buyer and writer are paying only small fraction of the price.

4. Futures
   Technically, “future contract” is a derivative because it does not trade directly the asset.
   1. Commodity Future
      “Commodity Future” is a contract that give the buyer a right to buy a real-tangible goods (e.g: gold, oil, silver, soy bean, iron ore, etc) at certain price in the date in the future.
      For example: a food company that require soy bean as one of their ingredient will know that by December they need 5 ton of soy bean. Let assume today is still July. Does the company just do nothing and wait until near December? How if there is a shortage and they cannot get the ingredient by December? Of course that’s not acceptable. Hence the company can buy 5 future contract where each of the contract allow the company to buy 1 ton of soy bean at certain price  to be delivered in December. So, at this stage no soy bean is exchange hand, just the right.

      On the other hand, for the seller of the contract (i.e: the farmer), they know how much they can produce (their capacity) and also know that the product have to be sold before it got rotten. Hence selling future contract is one way to make sure that they will have certain assurance that the product already has a buyer.

      Read “How Commodity Future Produces Profit for Trader” (to be released) for more detail.

   2. Index Future
      “Index” is a sum of stock price from a number of companies. For example: Dow Jones Industrial Index is combination of stock price from 30 big US companies. S&P500 index on the other hand is combination of price of stock from 500 companies.For example: let say we are now in July and the S&P500 is now at 900 point and every point of future contract “Mini S&P500″ for December is $70. Then if a trader expect the S&P500 will go up before December, he/she will buy this index future contract for $63,000 per contract (900 x $70). If the index in December become 1100, then he will received $70 x 1100 = $77,000 and pocketed $14,000 profit.

      Furthermore, the trader did not actually need the whole $63,000 to start with. The trader only need to put a collateral or margin as low as $5,000 in order to execute the trade in example above which make it very attractive.

      Read “How Index Future Produces Profit for Trader” (to be released) for more detail.

5. Foreign Exchange (Forex)
   Foreign Exchange (Forex) is a conversion between a currency to other currency. For example: 1 Australian Dollar converts to 80c US Dollar. If you want A$10,000 then you need US$8,000 to buy it. If a few week later the the Australian Dollar get stronger and A$1 can buy 90c US Dollar, then the A$10,000 can be converted back to US$9,000 -or- US$1000 profit (less commission)The exchange rate is always between 2 currencies (pair) and it is heavily depended to the macro economy condition of the 2 countries as well as the supply and demand of each currency

   Read “How Foreign Exchange Produces Profit for Trader” (to be released) for more detail.

Each instrument above has unique characteristics. The reason we need to know all of them is not because you want to trade all of them, but mainly for you to choose which instrument is suitable for you.

Next read suggestion: “How The Price Move in Market“

Denis Kristanda