Although some of the biggest news headlines related to finance tend to mention the stock exchanges of Wall Street, it is important to note that this is only one of many trading markets currently operating around the world.
The trading of financial instruments is hardly limited to stocks, there are also bonds, commodities, future contracts, currency pairs, options, and other derivatives that can be purchased and sold for profit. When Wall Street is mentioned in the context of financial trading, most people think of the New York Stock Exchange and the Nasdaq, which are largely marketplaces for the trading of public equity securities, which are also known as shares.
All financial instruments can be traded, including cash. It so happens that the dynamics of stocks, commodities and futures have been traditionally linked with major retail trading marketplaces such as Wall Street. It is important for traders to learn the definitions of these major instruments so that they can focus on just one of them or research the possibility of trading others as well.
When stocks are mentioned in the financial news, the instruments being reported are actually marketable securities also known as publicly traded equities.
The stock of a company represents the equity that can be distributed among its owners. The stock can be divided into shares in accordance to financial rules and the intentions of the company principals. The capital stock of a company more or less represents its valuation as it appears on its balance sheet. If a pizza delivery shop owned by two individuals is worth $50,000, the owners could resolve to issue two shares worth $25,000 to represent the stake in the business. The ownership of shares can be documented by means of legal documents known as stock certificates.
Shares are fractional representation of company stock. When major companies such as Microsoft are accepted by the United States Securities and Exchange Commission as publicly traded entities, their shares are listed on a marketplace such as the Nasdaq so that they can be bought, sold and traded by the public. In the case of Microsoft, which trades under the symbol MSFT, 7.78 billion shares were distributed among shareholders in early 2017; the capital stock of the company, also known as its market capitalization, was $485.34 billion.
It is important to note that shares denote fractional ownership of the company. If an individual amasses a large percentage of shares, he or she may be able to exercise strong voting rights and confer with the executive board about what the company should do to stay financially profitable.
Agricultural and mining products that are part of primary economic sectors are known as commodities. Soft commodities may include crops and livestock such as coffee, rice and even pork bellies. The two most traded hard commodities are oil and gold.
Long before shares were traded on Wall Street, financial instruments representing commodities were handled in ancient Babylonia. In fact, the Amsterdam Stock Exchange, which is considered the earliest example of a modern marketplace for trading financial instruments, was originally set up to trade commodities.
Commodities can be traded directly for cash at farmers markets, wholesale systems or export markets. In the financial realm, commodities are more likely to be traded as derivative instruments such as futures contracts at exchanges such as the Chicago Board of Trade or even the Chittagong Tea Auction in Bangladesh.
The physical trading of commodities at levels larger than wholesale is not practical. In the 17th century, rice traders in Japan perfected mechanisms to trade derivatives in the form of futures contracts, which are agreements to buy certain quantities of commodities or even other financial instruments at a set price without having to actually take physical delivery.
Futures contracts are based on underlying assets such as coffee, gold, rice, oil, foreign currencies, financial indices such as the Dow Jones Industrial Average, and even single stocks. In a way, futures contracts have the ability to make a commodity of just about anything of value that can be tracked by regulated exchanges.
It is worth mentioning that futures contracts have expiration dates that trigger certain clauses. If a trader purchases a futures contract on an order to buy 50 bags of Arabica coffee at a set price by February 28, this does not entirely bind her to accept delivery of nearly 3,500 kilos of beans to her doorstep. Depending on market conditions, an expired futures contract may still carry enough value to be traded; however, this may not be the case for options contracts, which are derivatives of derivatives.