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The global markets, and the instruments that track them

Seven markets, the categories inside each one, and the single contract that lets one account reach all of them.

Lesson 2 of 12. It matters because the fundamental you are about to learn does not act on "the market" — it acts on a category, and the categories do not respond alike.

Seven markets, and why the categories inside them matter

Financial markets divide into seven, and every one of them divides again. The second division is the useful one. A rate rise is not good or bad for “stocks” — it is bad for a growth stock that is funding its expansion with debt and close to neutral for a defensive stock selling something people buy anyway.

So the categories below are not vocabulary. They are the resolution at which fundamental analysis actually works, and every later lesson lands on one of them.

Seven market columns, each split into the categories the source divides it into
Seven markets and their sub-types. The second row is where a piece of news lands — the first row is too coarse to be acted on. Click to enlarge

Commodities: four groups that behave differently

Energy — coal, Brent crude, gasoline, natural gas. Consumption is close to non-negotiable, which is what makes energy prices feed almost immediately into inflation, and inflation into the rate decisions of lesson nine.

Base metals — lead, copper, nickel, zinc: common metals that tarnish or oxidise in air, are often cheap to extract, and are consumed by manufacturing. That last property is why copper is read as a growth signal rather than as a metal.

Precious metals — gold, silver, platinum, held mostly for investment rather than for use. They compete with interest-bearing assets, which is why they fall when real yields rise.

Agricultural — grown or raised: corn, beef, the direct products of land. Weather-driven and seasonal, and the least connected of the four to monetary policy.

  • Energy is the fastest route from a commodity price to a central bank decision.
  • Base metals track industrial demand, which makes copper a read on growth.
  • Precious metals are priced against yields, not against demand for metal.

Equities: eight kinds of share, and what each one fears

The source splits the stock market eight ways. They are worth keeping because they sort cleanly by what damages them.

  • Growth — companies reinvesting constantly and expanding fast. The most rate-sensitive of the eight, because their value is mostly in future earnings.
  • Dividend — structurally large, stable, and able to pay a share of profit out at year end. They compete with bonds, so they suffer when yields rise.
  • Defensive — resist sharp economic downturns, because what they sell is bought in a downturn too.
  • Income — grow slowly and pay the holder a steady return.
  • Penny — newly formed, low value, capable of moving several per cent at a time.
  • Speculative — swing hard with the market rather than with their own business.
  • Cyclical — react fully to the economic cycle, so they are the clearest read on it.
  • Value — judged by investors to be trading below what they are worth.

Forex: three tiers, and the dollar decides which

Currency pairs sort by one question — is the US dollar in it, and is the other side an industrialised economy.

Majors carry the largest share of all trading, and every one of them is the dollar against a developed economy: EUR/USD, GBP/USD, AUD/USD, NZD/USD, USD/CAD, USD/JPY, USD/CHF.

Minors are what is left when the dollar is removed from two majors — EUR/AUD, GBP/JPY, CAD/CHF, AUD/NZD. They are the same economies, so a minor is often best read as the difference between two major stories rather than as one of its own.

Exotics pair a major currency with a developing economy — USD/ZAR, EUR/TRY, JPY/NOK, AUD/MXN. Thinner, wider spreads, and far more sensitive to a single domestic event.

Currency pairs sorted into majors, minors and exotics
Seven majors, and everything else built out of them. This is the same list the instrument specifications reference works through contract by contract. Click to enlarge

Money, derivatives and funds, briefly

Three markets a currency trader touches indirectly but should be able to name, because the yield curve of lesson eight is built out of the first one.

  • Commercial paper — short-term unsecured debt issued by a company.
  • Certificate of deposit — a savings account holding a set sum for a set term, six months to five years, with the issuing bank paying interest for it.
  • Repo — short-term borrowing, mostly against government securities, where the seller buys the security back later at a slightly higher price.
  • Bond — a fixed-income instrument representing a loan from an investor to a borrower, typically a large company or a government.
  • Treasury bill — a short-term debt obligation of the US government, backed by the Treasury, maturing in a year or less.
  • Futures — a contract obliging both sides to trade an asset at a date and price fixed in advance, whatever the market price is on expiry.
  • Forward — the same idea without an exchange supervising it, settled between the two parties.
  • Option — unlike a future, the holder is not obliged to go through with it.
  • Swap — one side pays amounts based on one variable (a rate, an exchange rate, a commodity price) and receives amounts based on another.
  • ETFs — funds tracking fixed income, a currency, property, commodities, equity income or a defined risk profile.

The contract for difference, and what it is not

Almost every retail account reaching these markets does it through one instrument: the contract for difference. It is a derivative — an agreement under which the two sides pay or receive the difference between the opening and closing price of something, without that something ever changing hands.

That is what makes one account able to hold Apple, gold, copper, the German ten-year and crude oil. There is a CFD written on each, and its price tracks the underlying.

What the price tracking hides is that the trade is not the same trade:

  • You are not buying the asset. You are entering a contract with your broker about its price, and your broker is the counterparty rather than an exchange.
  • Holding costs money. A position left open overnight is financed, and on a long-held position that financing can outweigh the move you were right about.
  • Short is as easy as long, which the underlying rarely is. That is the real advantage and it is the reason CFDs exist at all.
  • The tick value need not match the futures contract on the same market — the instrument specifications page sets the two side by side, and on three of the seven currency contracts they disagree.
The underlying asset with delivery and ownership on one side, the contract for difference with only the price difference settled on the other
The same price on both sides. The counterparty, the carrying cost and what you own are different on each. Click to enlarge

What to take from this one

Two things:

  • News does not land on a market, it lands on a category. Knowing whether the share is a growth share or a defensive one, or whether the pair is a major or an exotic, is what turns a release into a direction.
  • The instrument you hold is not the asset you are analysing. Analyse the underlying; price, size and cost the contract you are actually in.

Next: which currencies rise on bad news

Why the yen and the franc rise when the news is bad and the Australian dollar falls, and how that split decides which way you are leaning before you trade.

Back to the twelve lessons