A financial market is any marketplace where investors trade securities or commodities on an open exchange with transparent orders and transactions. Financial markets generally offer low transaction costs and high trading volumes.
Financial markets mainly trade in equities, bonds, commodities, foreign exchange and derivatives, among other financial instruments.
A financial market is contrasted with financial instrument trading that is largely performed bilaterally and with little to no public knowledge, otherwise known as over-the-counter (OTC) trading.
Features of a Financial Market
The defining features of financial markets are their openness and transparency contrasted with their informality of exchange. This means that an extremely large number of buyers and sellers can make a similarly large number of transactions in a small amount of time without ever contracting directly.
The financial market acts as a medium of exchange and a clearing house so that market participants can make their trades with a maximum assurance that they are receiving the optimal current market price and that all agreed-upon transactions will be cleared in a timely manner.
By contrast, over-the-counter trading is known for opaque and often closed practices that make price discovery difficult and which carry the threat of counterparty non-compliance.
Common Types of Financial Markets
The financial markets are broadly divided into a number of categories based on the type of securities that are traded.
• Stock Markets
• Bond Markets
• Commodity Markets
• Money Markets
• Derivatives Markets
• Foreign Exchange Markets
• Interbank Lending Markets
Financial Markets and Trading
Day trading itself is largely the product of the introduction and ongoing development of contemporary financial markets. The extremely high volumes of trading and full transparency offer a source of public information on the market’s view of security that makes day trading strategies possible.
Not only do financial markets offer the information necessary for the vast majority of day trading strategies, they also offer the means for making the quick and low-cost transactions that are often essential to the effectiveness of day trading strategies.
This does not, however, mean that day traders cannot find opportunities to profit outside of traditional financial markets. The features of contemporary financial markets that make them so effective are also the features that tend to drive many profit-making opportunities quickly to zero.
By contrast, the opaqueness and inefficiencies of over-the-counter transactions mean that they can often be exploited for profit when informational asymmetries exist.
Traders should familiarize themselves with the details of the different financial markets that they intend to trade in. Order clearing can be of significant importance in terms of day trading, as can be the exercising of options in derivatives markets.
For example, some markets will only offer European-style option exercising, meaning that derivatives can only be exercised on their expiration date, which drastically impacts their price and trading.
Different markets will also have different hours of activity depending on geographic location, with certain parts of the day offering different trading volumes and sizes of bid/ask spreads.
Many successful day trading strategies focus on certain markets at certain parts of the day, such as trading European equities as the Frankfurt and London equity markets close.
Final Thoughts
The structure of contemporary financial markets is a defining feature of the modern investing world. These hyper-efficient and highly digitized marketplaces offer a dizzying array of potential trading strategies that would be unthinkable even a few decades ago.
From high-frequency traders (HFTs) to fully-automated algorithms, the investing world is now dominated by fast and efficient traders trading incredibly high volumes of securities using strategies that are either enhanced by automation or completely automated.
These financial markets represent an abundance of profit-making opportunities for day traders who are attuned to this new reality. While a day trader will be hard-pressed to beat an algorithm when it comes to scanning a news piece for relevant information, algorithms are notorious for making common and predictable errors of interpretation that human day traders can exploit.
The dominance of contemporary financial markets by automation and digitization is mostly focused on ‘market-making‘, which is the profit gained from rapidly entering and exiting a moving price, often with little or no exposure to the actual direction of the price.
This creates opportunities for human day traders to exploit the common errors that these market makers are prone to make.