Markets Overview

Financial Markets - What are they?

When people talk about financial markets, they tend to think of the stock market where company shares are traded. However, the City consists of several linked markets, each concentrating on different financial instruments.

Many other things are also traded. There are markets for bonds, currencies and derivatives, for hard commodities such as gold and silver, oil (traded in units of barrels) and also for soft commodities such as coffee and cocoa.

Markets are sometimes defined by the types of organisations that trade in them - perhaps the most important is the interbank market. This is where the banks lend money to each other.

 

Main points about Financial Markets:

Within financial markets prices are changing all the time, depending on what is available and how many people want to buy it. The very act of buying can move the market against you. That is why market liquidity is important.
Financial instruments can be traded on domestic markets (that is within a country itself) or on international markets. One example is the bond market, where 25% is traded internationally and the remainder is traded on domestic markets.
In some markets there is no central exchange where financial instruments can be traded. Instead people trade directly with each other, often online. This is called trading 'over the counter' (OTC). The foreign exchange market is an example of an OTC market.
Other markets use a central exchange, called a stock exchange. These are highly regulated markets where you need to meet certain conditions to trade. Find out more about stock exchanges..
The interbank market is where banks borrow and lend money to each other. This allows them to ensure they can meet any shortfalls and earn interest on any excess assets (see 'All about Banks').
The term 'capital markets' refers to the trading of securities (bonds and shares).
The term 'money-markets' does not refer to markets where money is traded but to the cybermarket where short term bonds and overnight deposits are traded and placed, and where governments, in the guise of central banks, interact with the financial markets.
One market where money is actually traded is the Foreign Exchange Market (Forex). It is the single biggest money market in the world. Find out more about the FOREX.
Some markets are extremely large. The international bond market is probably the largest financial market in the world. Worldwide, the total value of bonds in issue is about $40 trillion, of which about $10 trillion is traded internationally.
 Another important market that is related to the financial markets is the Baltic Exchange. This market is concerned with the buying and selling of capacity on cargo ships. Four fifths of the world's goods are moved by ships, so it is considered to be an indicator for the future state of the global economy.
 
 

Liquidity - the most Important thing in a Market

In terms of a particular market, liquidity is the measure of how easy it is to buy and sell financial instruments in that market.

The deeper a market, the more liquidity it is said to have and the easier it is to move in and out of the market by buying and selling.

How does this work? Well, just imagine if you were in a small group of six and you each had a batch of fruit for sale; if you bought a large quantity of fruit from the person standing next to you, the others in the group would be very likely to notice. If there were a hundreds of people in the group all buying and selling, most of those people in the group would not notice what you had bought.

It's similar in the financial markets: the deeper the market, i.e. the more people that are trading in that market, the easier it is to buy and sell without being noticed.

The reason this is important in financial markets is that, as prices are changing all the time, if liquidity is poor, trading in a market may move prices against you.

For example, say you were looking to buy a significant number of shares in a company. Once it was realised that the shares were being actively sought, the price of the remaining shares would rise because those selling would be trying to obtain the best price from their investment.

So, liquidity determines if you can trade and how efficiently you can trade (that is at what price).

Markets with poor liquidity may 'dry up' as nobody wants to trade in them.