Learn About The Different Markets

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3 Global equities Indices Types of indices Sector bets Trading commodities What typically affects the commodity markets? Why should I add commodities to my portfolio? Introduction to Foreign Exchange (FX) What is Foreign Exchange? The importance of US economic figures on the currency markets Treasury bonds What is a bond? Summary Test your knowledge Answers for page

4 This chapter will teach you about the different markets you can trade and will give you the basics on shares, indices, sectors, commodities, Foreign Exchange and treasuries. We also hold regular seminars in our London, Edinburgh and Dublin offices that cover these topics. To book some of our courses, please visit our educational website for more details at www. cmcmarkets.co.uk/education or the click the Trading IQ icon on your Marketmaker:Web platform.

5 Global equities So far, we ve concentrated on UK shares, which are only a small selection of the instruments you can trade with us. We are now going to take a look at the other products you can spread bet - the basic principles that you have already learnt still apply. Remember that you can spread bet on the price of shares from all over the world. Companies such as Pfizer, Google, Puma, BMW and Toyota can be found on Marketmaker:Web even though they trade on markets outside the UK. One difference between spread betting on UK and non-uk shares is the way that the price is quoted. For every penny a UK share price moves, you make or lose your chosen bet size, given in Pounds Sterling ( ) or Euros ( ) if you live in Ireland. The price on US shares and some European shares are quoted in US dollars (US $) or Euros ( ), but for each cent movement you make or lose the amount you chose to bet. European countries not using the Euro will have stocks quoted in their relevant currency, for example, Swiss shares are quoted in Swiss francs (CHF). Let s have a look at a US spread bet example. 5

6 US Spread Bet example Indices Suppose you want to trade Microsoft (MSFT) which is priced at US $34.01/34.13 and you decide to buy (go long) at 1 per point. These prices are in US dollars but your gains or losses are based on the cent movement. Your total exposure is 3413 cents x 1 a point which equals Our margin requirement on US stocks is 5% so your margin requirement on this trade would be: (3413 X 5%) = For every cent movement in Microsoft, you make or lose 1. If Microsoft s share price moved from US$34.13 to US$35.00 then it has moved 87 cents/points making you a profit of A stock market index is made up of all the shares listed on a particular stock exchange. Most indices can be said to represent the performance of a whole stock market and so they reflect investors sentiment on the state of the economy. The most heavily traded market indices are the American Dow Jones Industrial Average and S&P 500 Index, the UK FTSE 100, the Japanese Nikkei 225 and the German DAX 30. Remember, we call the indices by different names. As a rule we usually call our indices by the country of origin - e.g. UK100. All our index prices are a cash price based off the near future price. We take the future price, deduct any fair value and cost to carry (dividends, financing etc) and arrive at the cash price. FTSE 100 Dow Jones CAC 40 DAX 30 S&P 500 NASDAQ 100 Nikkei 225 UK100 US30 FRENCH40 GERMAN30 SPX500 NDAQ100 JAPAN225 Did you know over 57% of all spread bets traded with us are on indices? 6

7 Types of indices A price-weighted index A price-weighted index includes stocks based on their price. They are included in proportions based on their quoted prices. So, for example, a stock trading at US$100 will make up: 10 times more of the total index compared to a stock trading at US$10 20 times more than a stock trading at US$5 50 times more than a stock trading at US$2 A price-weighted index such as the US30 does not accurately reflect the market values of the stocks in the index. This is because a $100 stock might be that of a small company and a $10 stock that of a large company. A price-weighted index will be affected more by a change in the small company s share price (because it has a larger share of the index) than a change in a large company s share price. A market-price weighted index In contrast, a market-weighted (or capitalisation-weighted) index such as the UK100 is based on the market values of the companies that make it up. The market value is the number of shares issued multiplied by the share price. A small shift in the price of a large company has a large effect on the index. In the UK100 index, companies like BP (BP), Shell (RDSA) and Vodafone (VOD) make up a large percentage of the value. Those three alone make up almost 15% of the total value of the index. Please see the pull-out at the back of Trading IQ for a list of the most popular indices and their NTRs (notional trading requirements). 7

8 Sector bets Trading commodities You can also spread bet on different market sectors such as the banking, mining and pharmaceutical sectors. This works in a similar way to an index bet where our spread bet price reflects the total value of each sector. Trading the sectors gives you the option of taking a wider view, it s like picking a basket of shares in a particular industry. The commodity markets are more advanced than the equity markets. With this in mind, you should try to find out as much as you can about this broad market category before making any trading decisions. Like any market, the risks that you take when trading commodities can be managed but only after you have a full understanding of the product that you are trading. The modern commodity market dates back to the trading of agricultural products. While wheat, corn, cattle and pigs were widely traded in the 19th century in the United States, other foodstuffs such as Soybeans were only added quite recently in most markets. For a commodity market to be established, there must be very broad agreement on the variations in the product that make it acceptable for one purpose or another. 8

9 What typically affects the commodity markets? The price of commodities can be influenced by a number of basic factors that affect supply and demand. These include: Climate and weather Diseases and pests Political instability Regulations The overall economic strength of different countries As an example, the price of oil more than doubled due to a number of factors coming together including: The Iraq war (which affected oil production in the Middle East) Hurricane Ivan which hit US production in the Gulf of Mexico Rebel activities in Nigeria Growing demand for oil from China Political instability In contrast, the price of coffee has been dropping for several years now, due to supply outstripping demand. Vietnam has increased its coffee production by about 1,400% in the past 10 years and has replaced Columbia as the world s second-largest coffee grower after Brazil. Vietnam s rise as a major producer of coffee has been a key contributor to the coffee glut. 9

10 Why should I add commodities to my portfolio? Commodities remain one of the most traded financial instruments in global exchanges. The high volume and value of transactions will give you an exposure to a very liquid market (the Chicago Mercantile Exchange processed a total million contracts valued at US$ trillion during the first half of 2008). Another attraction of the commodities market is the relatively low cost of entry. Spread Betting provides you an exposure to commodity markets. As spread bets on commodities are traded on a margin, you can increase your exposure to a certain instrument or market at a relatively low cost. With some of our commodity spread bets you can trade on the Daily Rolling Cash price or you can select our Forward Rate Bet. This is the same as a Quarterly Bet but only covers one month. Here are some of the NTRs (notional trading requirements) and spreads of our most popular commodity bets. NTR Spread Trading hours (UK Time) US Crude 140 points 6 points Opens Sunday 11pm to Friday 9pm XAUUSD (GOLD) 30 points 5 points Opens midnight Monday to 9pm Friday (UK winter) 1am Monday to 9pm Friday (UK Summer) Natural Gas 35 points 4 points Opens Sunday 11pm to Friday 9pm Soy Beans 180 points 10 points 3:30pm to 7:15pm NTRs, spreads and trading hours can be subject to change. 10

11 To help you understand trading commodities better, we will look at an example of trading US crude. Suppose you decide that US crude will continue to go up in value as it has recently reached a new all-time high. You decide to buy (go long) at for 2 per point. The NTR for US crude is 140 points so your margin requirement will be 140 x 2 = 280. Good news! US crude has climbed even higher by 106 points to / so you decide to close out of your position. You have just made 106 points at 2 per point = 212 profit. 11

12 Introduction to Foreign Exchange (FX) The Foreign Exchange market is one of the most liquid and largest of the financial markets, making it an ideal part of a trader s portfolio. This introduction to trading Foreign Exchange will give you the basic information to understand the FX market. It will introduce you to: The major instruments available for trading The big players in the FX market Other market characteristics and conventions such as trading hours and terminology Background Foreign Exchange markets were originally developed to cater for the supply and demand for different currencies by governments, companies and individuals including currency speculators. They exist to service international trade and the international movement of money and capital. However, today an enormous proportion of FX market activity is being driven by speculation, arbitrage (simultaneous buying and selling) and professional dealing, in which currencies are traded like any other commodity. Importers and exporters, international portfolio managers, corporations, speculators, day traders, long-term holders and hedge funds all use the FX market to: Pay for goods and services Deal in financial assets Reduce the risk of currency movements by hedging their exposure in other markets. Transactions in Foreign Exchange are now worth more than $1.9 trillion a day. 12

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14 What is Foreign Exchange? Foreign Exchange is about exchanging one currency for another. Unlike other financial markets, the FX market has no physical location and no central exchange. It operates through a global network of banks, corporations and individuals trading one currency for another. The FX market is the world s largest financial market, trading 24 hours a day with enormous amounts of money traded on a daily basis. Unlike any other financial markets, investors can respond to currency fluctuations caused by economic, political and social events at the time they occur, without having to wait for the markets to open. So trading FX is potentially less prone to slippage than trading the stock market where you are often exposed to price gapping between the time the markets close and re-open. Access to modern news services, charting services, 24-hour dealing desks and sophisticated online electronic trading platforms for retail investors has seen speculation in the FX market explode since the mid 1990s, particularly for the smaller and medium-sized investor. The currency markets are not new, they ve been around for as long as banks have been doing business. What is new is the accessibility of these markets to traders like yourself. The last decimal place in an exchange rate quote is referred to as a point or pip. Many of our foreign exchange prices quote a fixed 2 to 3 point spread between the bid price (the price you can sell at) and offer price (the price you can buy at) on the major currency pairs. With our FX spread bets you can trade on the Daily Rolling Cash price or you can select our Forward Rate bet which is essentially the same as a quarterly bet but only covers one month. 14

15 Here are some of our NTRs (notional trading requirements) and spreads on our most popular FX spread bets. NTR Spread Trading hours (UK Time) GBPUSD (Sterling vs US Dollar) 150 points 3 points Sunday 9pm to Friday 10pm EURUSD (Euro vs US Dollar) 150 points 2 points Sunday 9pm to Friday 10pm USDJPY (US Dollar vs Japanese Yen) 150 points 3 points Sunday 9pm to Friday 10pm USDCHF ( US Dollar vs Swiss Franc) 150 points 3 points Sunday 9pm to Friday 10pm USDCAD (US Dollar vs Canadian Dollar) 100 points 4 points Sunday 9pm to Friday 10pm NTRs, spreads and trading hours can be subject to change. 15

16 A Foreign Exchange order To help you understand trading FX better, we will look at an example of trading GBPUSD (Sterling vs US Dollar) which is known as Cable in the FX market. Suppose you decide that GBPUSD is going to go higher in value as it is reaching a resistance level you don t expect to hold. This is covered in more detail in Module 6 You decide to go long (buy) at for 1 per point. The NTR for GBPUSD is 150 points so your margin requirement will be 150 x 1 = 150 If GBPUSD goes up 50 points, our spread bet price increases and to sell you are quoted Your profit and loss on FX is dictated by the movement circled above multiplied by your chosen amount for each point In this example, you have just made 50 x 1 per point =

17 The importance of US economic figures on the currency markets Throughout the calendar month, US economic figures are regularly released. These figures can have a major effect on the FX markets and even on stock markets across the globe. Non-farm payrolls This figure is released on the first Friday of every month and is probably the most important US figure and the one all traders look for. It measures the change in the number of employed people during the previous month, but it doesn t include the farming industry. A rising trend has a positive effect on the nation s currency. Job creation is an important indicator of economic health. Consumer spending, which is closely linked with labour conditions, makes up a large portion of GDP. This report is the first of the month that relates to labour conditions which means it could contain some big surprises. 17

18 Trade balance This measures the difference in value between imported and exported goods and services. A positive trade balance indicates that more goods and services were exported than imported over a given period. A rising trend can have a positive effect on the nation s currency because when a country s levels of exports are high, demand for that country s currency rises as buyers convert their own currency to purchase the exports. The trade balance also has a big impact on GDP because high demand for exports creates increased employment and production as companies work to satisfy this demand. US interest rate decision Eight times a year the Federal Open Market Committee (FOMC) votes on where to set the United States short-term interest rate (also called the federal funds rate ). Shortly after each vote, the FOMC releases a statement that contains: The outcome of the vote A brief commentary on the economic conditions that affected their decision Clues about how they may vote in future A rising trend in interest rates has a positive effect on the American currency. Short-term rates are the most important factor in valuing currency, traders look at most of the other indicators only to predict how interest rates may change in the future. High interest rates attract foreigners looking for the best risk-free return on their money. This can dramatically increase demand for a nation s currency. The decision on where to set interest rates depends on a number of facts. The primary objective of the central bank is to achieve price stability; when inflation rises above an annualised rate of approximately 2%, the bank will respond by raising interest rates in an attempt to bring prices down. Retail sales Retail sales measures the value of the sales of goods and services to consumers. A rising trend usually has a positive effect on a nation s currency because retail sales make up a large portion of consumer spending. This is a major driver of the economy and has a large impact on GDP. Traders pay close attention to retail sales because it is usually the first major indicator of the month that relates to consumer behaviour which means it could contain some surprises. 18

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20 Treasury bonds What is a bond? Treasury bonds are more complex than equities and index products. Most countries issue treasury bonds which they use to ease seasonal fluctuations in government-related cash flow. You can spread bet on these instruments with us. They are sensitive to interest rates and reflect the cost of borrowing in the short term. The treasury market can be affected by interest rate risks and inflation risks. While you are guaranteed to receive the interest and principal (the original amount) on your investment, the underlying value of the bond may change depending on the direction of the interest rates. You do not receive the full value of the bond by spread betting as the underlying value is not actually delivered. If the interest rates rise after a treasury bond is issued, the value of the security will fall, since bonds paying higher interest rates will come into the market. On the other hand, if interest rates fall, the value of the older, higher paying security will rise in comparison with new issues. In finance and economics, the issuer of the bond has to pay the bondholder the principal (the original amount of the loan) plus interest. So, a bond is essentially an IOU ( I owe you contract) issued by a private organisation or government. The issuer borrows the amount the bond is worth from its buyer, pays interest on that debt while it is outstanding and then redeems the bond by paying back the debt. Bonds are securities but unlike shares which represent ownership of interest in a company (termed equity) bonds are merely debt. So, a shareholder is an owner but a bond holder is a creditor. Many investors include bonds in their portfolio so their capital is not all tied up in stocks. Stocks and bonds often trade in different directions which is why bonds can be used to reduce risk. A strong market is good for stocks but can cause bonds to fall as positive trading may encourage investment away from the risk-free rate of return. So, events that cripple stock markets can result in bond prices picking up. All treasuries and bonds we quote are based on the futures prices. 20

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22 Now you should be able to: P P P P Place your first index spread bet Have a better understanding of the commodity markets See the benefits of trading FX and the importance of US economic figures Know how treasuries and bonds can add to your portfolio 22

23 Test your knowledge Try to answer as many questions as you can and then turn to page 26 for the correct answers. 1. What is the NTR for trading gold? 2. What is your margin requirement for buying (go long) Pfizer on the US market at 1 a point trading at 31.59/31.70? The margin is 5% on most major US stocks. 3. How much margin is required to trade GBPUSD at 2 a point? 4. When are the Non-Farm Payroll figures usually released? 5. Name five commodities you can trade. 6. What hours can you trade the US30? 23

24 Notes and calculations on other financial markets you can trade with Spread Betting 24

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26 Answers for page points x 1 x 5% = The NTR for GBPUSD is 150 points, 150 x 2 = 300 margin requirement. 4. The first Friday of every month. 5. Oil, Natural Gas, Gasoline, Copper, Platinum, Palladium, Soya, Cotton, Lumber, Corn, Oats, Pork Bellies, Orange Juice, Rice, Wheat, Sugar, Cocoa, Coffee pm Sunday pm Friday 26

27 Risk Warning Remember Spread Betting is a leveraged product and carries a high level of risk to your capital. It is possible to incur losses in excess of your initial stake. Spread Betting may not be suitable for everyone, so ensure that you understand the risks involved and seek independent advice if necessary.

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