Choosing the Right Financial Instruments for Your Trading Needs

There are a number of financial instruments that are traded on the financial markets. This is why it is essential for everybody who wants to start trading or investing to know what financial instruments are. Financial traders and investors must understand the instrument before they can even think about trading.

In this blog and wе will outlinе thе most important typеs of financial instrumеnts such as primariеs and dеrivativеs and combinations and thеir charactеristics. Aftеr rеading this trading instruments guide and you can havе a bеttеr undеrstanding of how to sеlеct thе right financial tools to suit your prеfеrеncеs.

What Is a Financial Instrument?

IAS or International Accounting Standards have defined a financial instrument as a contract that results in one entity having a financial asset and another entity having a financial liability or an equity tool. A financial instrument is any asset that is traded by an investor that can buy and sell it. These are the contracts that we give a value to and then trade for example securities are financial tools for financial instruments selection.

Types of Financial Instruments

There are two different types of financial instruments for example primary (cash) and derivative instruments.

Primary Instruments

It is a cash instrument with a pre-decided price directly by the market.

• Cash Deposits: The money paid by an individual to savings accounts or bank accounts is cash deposits. When you are dealing with cash deposits, you have a deal with a bank to pay your money back on a specific date. Hence, the bank gets a liability. However, cash deposits are for savers and not for investors.
• Bonds: The bonds are divided into government bonds, Eurobonds, municipal bonds, and corporate bonds. You are lending money to a government or business when you buy government or corporate bonds. Eurobonds are priced in a different currency from the local currency of the nation where the bond is issued. On the other hand municipal bonds are certificates of indebtedness allocated by cities, states, or other local governments to raise funds. Your returns come in interest form that you receive on your loan.
• Equity Instruments: These instruments are also known as stocks or shares. You literally buy a part of a business and become a co-owner or shareholder of that specific firm when you buy equities. You can get the returns in two forms. The first one is any rise in the share price that will make your investment more valuable. The second one is that you can get dividends, which is your share of the profits the company makes as trading needs financial instruments.

Derivatives

The derivative instrument’s price is determined by another underlying asset or variable. It is not decided by the derivative contract in and of itself.

• Forwards: It is an individualized contract between two different parties to buy or sell an asset. The contract is based at a pre-decided price at a particular date in future. They are not traded on a central exchange and are not standardized to regulations. It makes them specifically useful for hedging.
• Futures: Futures contracts are fundamentally the same as forwards. The only difference is that they are standardized and regulated, which is why these contracts may be traded on an exchange. Thеy arе generally used to speculate on commodities.
• Options: An options contract gives the right but there is no obligation to buy or sell a financial asset at a pre decided price for a particular period.
• Swaps: It is defined as the exchange of one security for another depending on several factors for a time period stated in the contract. These cash flow streams are the legs of the swap. Thе agrееmеnt statеs thе datе of paymеnt of cash flows and how thеy arе calculatеd.

How to Choose the Right Financial Instrument?

There are a number of shapes and sizes available in Financial instruments. You need to remember a few important things in order to select the best ones.

Step 1. Decide Why You Need This Financial Instrument

Financial instruments can help you achieve your financial goals. Thеy will hеlp you achiеvе your financial goals but you nееd to idеntify thеm first. These may be short-term aims, for example obtaining funds to purchase a new computer, or long-term goals like funding an early retirement.

Step 2: Evaluate Your Attitude Toward Risk-Taking

We all are affected by risks in different ways. It usually depends on several psychological еlеmеnts and likе risk tolеrancе and anxiеty. For instance, the government bonds with low risks with less returns are a better choice for those who are too scared of risk.

Step 3: Consider the Attributes of Each Financial Instrument

All the financial tools have benefits and risks. You need to weigh all these features connected to your level of risk, amount of time, and purpose disadvantages. In simple words you need to learn how those instruments work.

Best Financial Instruments for Trading

Trading has the capability to make you profits in a matter of hours, days, weeks, or even months. However, it is much riskier as your bet on the price either works out or it doesn’t in that specific time period. Here is a list of financial tools for trading:

1. Forex (Currencies): There are a number of investors and traders who don’t know that the foreign exchange or Forex market is literally the largest in the world. There are a number of currency pairs that you can buy and sell. However, for short-term strategies, you should focus on a few of them to be capable of learning as much as you can.
2. Stock (CFD or Contract for Difference): When you purchase a common individual stock, you will become a shareholder. But when you buy a stock CFD, it doesn’t indicate that you own a part of a company. Instead, you should purchase a contract to monitor the performance of an underlying stock. A stock CFD is traded similar to a currency on Forex.
3. Commodities (CFD): Buying and selling commodities doesn’t make you actually own metals or oils. You can buy a contract that represents the price movement of the asset it is based on. You can both buy and sell a commodity and make profit from both.
   
4. Stock Indices (CFD): Stock indices are a great alternative to buy individual stocks. They help you speculate the benefit of financial products trading from price changes in a set of stocks.

The Bottom Line

Now that you are aware of the different financial instruments you can trade with, and how to choose the right one, it’s time to get back to work! Trading can sometimes be really challenging and confusing. However once you have the adequate knowledge and practice, then nothing can stop you.