As a trader, it’s important that you know how to use various financial instruments. It is important that traders know about different financial instruments and be aware of the process when deciding the best one. There are many things to take into account when choosing a financial instrument. Each one comes with a set of advantages and disadvantages, and you have to assess all of them properly.
From considering its transaction costs and liquidity to its volatility and more, you must pay attention to everything. Instead of blindly choosing your financial instrument and getting yourself into trouble, read this article further down and learn how to select the right financial instrument to trade.
What is a Financial Instrument?
Financial instruments are tradable physical or digital documents that represent your ownership of a particular asset or right to receive something on a contractual basis. Financial instruments are easily changeable, and at the same time can be modified. Most financial instruments are tradable, but this depends on the amount of information available, as well as the liquidity.
Financial instruments are usually ones you can sell. If you have a contract to sell or buy something but are unable to sell the contract itself, then that is not a financial instrument. Financial instruments are those in which the contracts are sellable.
The Types of Financial Instruments
To select the right financial instrument, you must know the different types of instruments out there and if they are cash instruments or derivative instruments. Cash instruments are those that represent the actual ownership of a particular asset and the right of cash flow in the future. Derivative instruments are those that derive the price from other assets and financial instruments. Mentioned below are the different financial instruments for trading:
Bonds
Bonds are long-term debt instruments issued by governments, companies, and municipalities to raise money in the form of debts. The bond matures over time and gradually has a face value, along with a coupon that will indicate the interest paid every year to the holder.
Shares
Shares are also a cash instrument that represents the ownership of a publicly listed company. Shareholders can have particular rights, such as calling to a certain amount of assets in case of liquidity.
Money Market Instruments
Similar to bonds, money market instruments also have maturities and there are different types of them. These include repurchase agreements, certificates of deposit, treasury bills, and more.
Other Finical Instruments
- Cash
- (Exchange Traded Funds ETFs)
- Forwards
- Swaps
- CFDs
- Futures
- Options
How to Select the Right Financial Instrument?
If you want to meet all your financial objectives, then choose an appropriate financial instrument by looking at the right combination. Mentioned below are a few ways you can select the right financial instrument:
1. Lay Out Your Objectives
You must consider your objectives when choosing a financial instrument, as this will tell you whether you should go for a long-term investing financial instrument or one for trading. Investors tend to go for more than one asset class, while traders usually specialize in trading a single asset class.
2. The Type of Asset Class That Interests You
There are different types of asset classes such as currencies, bonds, equities, commodities, and real estate. The risk for each asset class differs. As the risk for those with higher returns, such as equities, is higher than those asset classes with lower returns like bonds. Choosing an asset class highly depends on the knowledge you have about the financial markets and instruments on the whole, and your interests as well.
3. Choose One That suits your objectives
Once you know what your objective is, you can choose a financial instrument accordingly. Some financial instruments have a single asset class, while others are derivative instruments and may have an underlying asset. While derivative instruments are more flexible when it comes to trading, you must always go for those that match the objective set.
Final Words
Now that you are aware of the different financial instruments to trade with, and how to select the right one, it’s time to get back to work! Trading can be really tough and confusing, but once you have the right knowledge, guidance, and practice, then nothing can stop you.
