What is Online Trading?

What is Online Trading?


18 Jul 2019

Trade exchange and investments have been a part of people’s lives in all developed countries for years now. However, it doesn’t mean that anyone can become a trader. In fact, until recently, it was quite an arduous task to get into this business – auctions were held exclusively in exchange buildings and one needed a license to have access. The Internet made the entire process of trading on the stock exchange much easier for everyone. This gave birth to a whole new trend – online trading. For some, it became a hobby, and to others, it became a full-time profession. And even though it has spread so widely among people, there still are many who do not know what online trading is, why it is so popular, and how simple it is to become a trader.

Online trading definition – What Is online trading?

Online trading is trading in financial markets via the Internet. Previously, all trading was held in the exchange building in person or by phone. Now, every deal is concluded with the help of an electronic terminal. 

All you need to start trading is a computer with Internet access and an installed trading system.

How does online trading work?

Internet-trading allows you to make deals on the financial market within seconds or even less. However, one thing still remains the same with pre-online times: a private trader still needs a broker in order to trade. A broker provides a trader with a trading terminal –  the software that a trader uses to conduct his business.

It goes like this:

  1. A trader decides to make a deal (for example, to purchase 100 shares of Apple).

  2. He finds this asset (Apples' shares) in his trading platform, chooses the quantity (100 pieces or 1 lot) and places an order to buy.

  3. The broker gets a request from a trader and starts executing the order. He needs to find a counterparty – another trader, who is willing to buy the same asset for the same price. 

  4. The broker looks for a counterparty on the stock exchange. When the search is completed, the deal is made.

Nowadays, the trading platform does all the work to find a counterparty and clinch a deal. The trading process is fully automatic; that is why the time needed to make a deal is no more than a couple of seconds. 

But it wasn’t always like this. In the early days, the whole process took a lot of time even though the chain “trader – broker – stock exchange – broker – trader” was the same. The trader used to give a call to his broker and ask to open the deal, and the broker would personally try to find a counterparty on the stock exchange. 

Leverage and Short-Trading

Leverage and Short-Trading

One of the most significant and important innovations that online trading brought is the possibility to trade using leverage and short-trading. Before, traders could only make deals for the sum which they actually possessed and which they deposited into the broker’s account. 

Now, private traders can conclude deals worth 100 times more than the capital they own.

One may ask, how is this even possible? This answer is “leverage” – the broker presents additional capital. To have a better understanding take a look at the following scheme:

  1. A trader wants to purchase 100.000 euros for dollars, but only possesses $1000.

  2. A broker provides the trader with the sum necessary for the deal. At the rate of EUR/USD 1.2000, he will require $120.000. 

  3. The broker makes a deal on behalf of the trader. $1000 in his account becomes a pledge.

  4. If the EUR/USD rate increases, the trader gets the profit. He can close the deal when the rate reaches, for example, 1.2100. In this case, the trader will receive $121.000. $120.000 goes back to the broker, plus the fee that he takes for concluding the deal and providing the leverage. Overall profit for the trader will be $1000 minus the costs. By doing this, the trader can double the sum in his account.

  5. If the EUR/USD rate decreases, the trader loses money. His losses are limited by his security deposit. In case the rate drops to 1.1900, the amount of working capital will decrease from $120.000 to $119.000. If this happens, the broker will have to forcibly close the deal to avoid further losses. The broker will take the remaining $119.000 plus $1000 which belongs to the trader to compensate for the loss. In this scenario, the trader can lose his entire deposit.

Thanks to the leverage, it is now also possible to use the short-trading scheme. A trader can not only buy assets worth much more than his deposit but also sell the assets he does not possess. For example, with only $1000 in his pocket, a trader can open a deal to sell euros (which he does not have) for dollars. In this case, the trader has to take leverage, though not in USD, but in EUR. The remaining part of the deal is similar.

Types of assets you can trade online

Types of assets you can trade online

There are several types of assets that you can use in online trading. Some of them are categorized as “classic”, and they have been sold for hundreds of years now. Others appeared after the spread of Internet trading. Let’s take a closer look at each category of assets.

Stocks

Stock market shares are one of the oldest types of assets. A stock share is a specific share of a big company that is traded publicly. There are two possible roles for you when making deals in the stock market: the speculator and the investor.

  1. A speculator makes short-term deals. His main goal is to buy low and sell high (or vice versa, to sell for a high price, then buy low). He does not care about any other peculiarity, the only thing that is important is the difference between the purchase price and the sale price.

  2. An investor does not just buy shares to sell them at a higher price. He invests money into the business that has issued the stock. A long-term investment is the highest priority for him. The main source of income for an investor is a dividend. However, the increase in the stock rate also makes his portfolio more valuable, which is also very important.

Cryptocurrencies

Cryptocurrencies

Cryptocurrency is the newest asset in contemporary financial markets. But what is it? Let’s dig deeper.

Cryptocurrency is a digital asset created by a complex program code. Bitcoin was the first and the most popular cryptocurrency, and many more were created from this basis. Today, there are more than 2000 different cryptocurrencies and the number is still growing.

Cryptocurrencies are different according to their structure, ideology, and the values they have. Some of them are just a new way of completing financial transactions and are more reliable, fast, and confidential than bank transactions (though there are certainly some cons in this approach). But some cryptocurrencies, or crypto assets, represent platforms for making different applications with advanced functionality or a wide variety of other interesting projects.

As cryptocurrencies are assets, their price is dynamically changing, which means that they can also be traded and bring profits. Just like with shares, you can speculate about cryptocurrency or invest in it (because almost every cryptocurrency has a value).

The main difference between shares and CC is very high volatility:

  1. The rate of an average share may rise by 20-30% in a year, and this will be considered a very good result.

  2. Cryptocurrency may rise by 200-300% in a month, then fall drastically to 20-30% in a day, and this will be considered a normal trend.

Currencies

Currency is the main asset for Forex trading. Currencies are commonly used in currency pairs, such as EUR/USD, GBP/USD, etc. Trading is conducted in one currency relative to another. However, for everyone’s convenience, currencies in a currency pair do not switch places. For example, if a trader wants to buy USD for GBP, he should open a deal to sell GBP/USD or “sell GBP/USD”.

Metals

Precious and non-ferrous metals are also a quite popular Forex asset. Traders mostly choose gold and silver; many brokers also allow trading platinum on their trading system. It is possible to make deals to buy or sell copper, nickel, aluminium and other precious metals. However, not all brokers give access to such assets.

Indices

Indices (indexes) – one more tool that is used on the stock market. The index is formed by a certain number of shares, which are generally combined into one category. For example, the Nasdaq 100 index consists of shares from the 100 biggest companies in the high-tech industry, which are traded on Nasdaq.

There are also many other indexes:  DJ 30, S&P 500, Nikkei 225, etc. Stocks in the index are often united by the fact that they are traded on the same exchange, just like Nasdaq 100 and Nikkei 225. The figures you see after the name of the index are the number of shares which form the index.

The index rate changes according to the dynamics of share prices it is formed from. For example, if the majority of shares from Nasdaq 100 rise – the index will increase too. And the opposite is also true. If the share prices are falling, the index rate will decrease too.

Agriculture

Agriculture category includes assets such as wheat, soybeans, beans, etc. These are not the most popular assets, as the price does not change often like exchange rates for gold do, for example. However, the fundamental factors that affect agriculture rates are clearer and easier than when dealing with currencies or gold. That is why these assets have their own permanent audience.

Oil and Gas

Oil and gas are the assets of the еру energy resources category. It is as popular a Forex asset like gold, second only to general currency pairs.

ETFs

ETFs are investments funds, similar to stock indexes. ETFs are a combination of shares and other assets, its rate changes in accordance with changes in the rates of its counterparts.

Types of investments

Aside from variable assets for online trading, there are several types of investments. Each type has its own approach, and the trader has to clinch the deal differently: markets, terms, and the contract period will not be the same. Let’s have a look at the most common types of investments.

CFD

CFD (Contract For Difference) is the equivalent of a stock market share, which can be traded at Forex. However, traders don’t buy and sell the share itself, but a contract instead. The terms of the contract define their profits or losses, in accordance with the price changes for this share.

This is the algorithm:

  1. Trader A bought CFD for a share at a price of $10, consequently, trader B sold CFD for a share at a price of $10.

  2. The share price reached $11.

  3. Trader A close CFD, his profit is $1 per share. But for trader B, closing the CFD means a loss of $1 per share.

In the end, traders received the same profits and losses as if they traded the usual shares. However, trading CFD allowed them to use the leverage and other advantages, provided by Forex brokers.

Binary options

A binary option is a type of financial instrument where the trader has to define how the price will change within a specific amount of time.

In a standard binary option, there are only three parameters:

  1. The direction of a price change (up/down)

  2. Expiration date

  3. Transaction volume (rate)

Binary options allow for a big profit, even if the price changes are not that significant. The trader needs the price to change at least one point in the specified direction and hold there until the expiration date. In this case, the trader will get 80-90% of his bid, which can be pretty high. Although the risks are quite high – if the price goes in the wrong direction, even by one point, the trader will lose his bid.

For example, let’s say a trader has a capital of $1000. He can open an option for EUR/USD with the following parameters:

  1. Direction – up

  2. Period – 5 minutes

  3. Rate – 100 dollars

If the price goes up by just one point during these five minutes, the trader will get 80-90 dollars profit (it depends on the conditions the broker set). If the price goes down, the trader will lose 100 dollars.

Futures contract

Futures contract

A futures contract is a way to trade goods like oil, palladium, or wheat in documentary form, without the direct exchange of “goods – money”. When concluding a futures contract, the seller undertakes delivering certain goods to the buyer, in a certain time frame, after making a deal (for example, in 3 months). However, the buyer doesn’t usually need the actual commodities, he needs the right to them so that he can make a speculative profit from trading this product. Buyer thus sell futures to other traders. 

Pros and cons of Forex and these types of investments

Let’s take a closer look at the advantages and disadvantages of these types of investments so that we are able to define the most profitable and promising approach to online trading.

TypeProsCons
CFD
  • The possibility to trade shares at Forex
  • Receiving the dividend
  • Leverage
  • The simplicity of executing the contract
  • Price stability
  • There is no stock itself, as a document
  • Low volatility – it’s hard to get a big profit in a short time
Binary Options
  • The simplicity of the trading
  • Potentially high profits
  • High risks
  • Lack of regulation in most European and American countries
  • Negative mathematical expectations
  • Only speculative operations
Futures contract
  • Trading goods with no direct exchange
  • Lack of leverage
  • Only speculative operations

As you can see, CFD showed itself as the most attractive variant for online trading. Moreover, contracts for the price difference are a generic instrument which will suit both investors and speculators.

Pros and cons of online trading

Now that we know a bit more about online trading, it’s time to evaluate it objectively and state its pros and cons.

Pros of online trading:

  • Potentially unlimited income.
  • The possibility to set your own work hours, without a strict timetable or location.
  • Can be combined with your main job.
  • This kind of work can be interesting for people who like finance, analyses, etc.
  • You can start trading, even without a large amount of capital.
  • Constant self-development and new experiences.

Cons of online trading:

✗ Financial risks.

 

✘You are your own boss, and you are responsible for your actions.

Can anyone become a successful online trader?

One can easily say that the recipe for becoming a successful trader is simple: have a lot of patience and emotional stability, be ready to be a better version of yourself and pursue your goal no matter what. 

There are a lot of people who have the potential to become a good trader. Unfortunately, 99% give up in the early stages.

But there is no common path to success, there is no one-size-fits-all plan on how to turn anyone into a professional and thriving trader that can make a fortune overnight. However, there are certain steps that are compulsory for anyone interested in investments or trading:

  1. Create an online trading plan. You’ve got to decide how and when you are going to trade, how much time you are ready to spend, etc. What are your goals? Will it be your main occupation or just a hobby?
  2. Set up functioning risk management. Both trading and investments require risk evaluations beforehand. Even though you start with a demo account, you have to assess the risks. Only invest the amount of money you can afford to lose. You also have to calculate the risk for each and every deal or trading session.
  3. Choose your trading style. A successful trader must have a trading strategy. That is why you have to know your methods of analyses, your market, type of assets and other nuances. You can start by using someone else’s strategy, but a truly large financial gain can only be made by implementing unique strategies.
  4. Take your first trading steps with your demo account. When you chose a strategy, try it out using the demo account. It would be wise to not switch to the real account unless your demo account is steadily gaining profits. 

Conclusion

Online trading is an interesting, perspective and profitable occupation. It allows you to gain financial independence and the possibility of spending your time the way you want to. It is a long path of working and learning before you can become a successful online trader. Though nothing worth doing is easy, right?

Traders and investors who have just recently started out have a good possibility of starting their online trading career with a Libertex platform. You will get a demo account for absolutely free, allowing newbies to practice and test their strategies. Moreover, Libertex was purely constructed for novice traders. That’s why it’s easy to learn how to use, and it is functional; even for a person who has never dealt in the high stakes arena of online trading before.

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