Asset Types in Forex Trading

An investment in knowledge pays the best interest.

Benjamin Franklin

Lesson 3: Asset Types in Forex Trading

Asset Types in Forex Trading

The term ‘Forex’ refers to the exchange of currencies against each other. 

Currencies that are traded against each other form a currency pair and have an exchange rate.

In online Forex trading markets, currency pairs are traded as Contract for Differences (CFDs).

CFDs are financial instruments to trade on the price changes of the underlying financial asset.

The scope of underlying financial assets in the Forex markets reach beyond currencies. There are seven common types of underlying financial assets in CFD trading:

Underlying Asset Examples
Currency Pairs EUR/USD, AUD/USD, USD/JPY, GBP/CHF
Commodities Gold, Silver Crude Oil, Coffee
Stocks Apple, Facebook, BMW, Sony
Indices Dow Jones 30, S&P 500, DAX 30, Nikkei 225
Cryptocurrencies Bitcoin, Litecoin, Ethereum, Ripple
Exchange-Traded Funds (ETFs) MSCI Emerging Markets, GDX Gold Miners, XLE Energy Sector, 
Treasury Bonds U.S. 5-Year Treasury Note, Euro-Bund, Japan Government Bond

Currency Pairs

A currency is a standardised measurement unit of a country’s economic value.

It serves as a valuation reference for products and services created in a country. 

Each currency has a three-letter symbol. The first two letters are the abbreviation of the country and the third letter is the name of the currency.

There are 8 major currencies:

These are the most traded and most liquid currencies in the financial markets.

The value of a currency is appraised in relation to other economies it interacts with. 

A currency pair is formed between the national currencies of two different countries. 

There are three main currency pair categories: majors, minors, and exotics.

Major Currency Pairs

Major currency pairs are formed between USD and other major currencies.

They represent 85% of the total trading volume in Forex markets.

Minor Currency Pairs

Minor currency pairs are formed between major currencies, except USD. 

They are the second most traded group of currency pairs. A few examples:

Currency Pair Symbol
Euro vs. British Pound  EUR/GBP
Euro vs. Australian Dollar EUR/AUD
Euro vs. Swiss Franc EUR/CHF
British Pound vs. Japanese Yen GBP/JPY
British Pound vs. Canadian Dollar GBP/CAD
Swiss Franc vs. Japanese Yen CHF/JPY
Australian Dollar vs. Japanese Yen AUD/JPY
Australian Dollar vs. New Zealand Dollar AUD/NZD
New Zealand Dollar vs. Japanese Yen NZD/JPY
New Zealand Dollar vs. Canadian Dollar NZD/CAD
Exotic Currency Pairs

Exotic currency pairs include one major currency, like American Dollar (USD), and one exotic currency, like South African Rand (ZAR). 

The exotic nature of currency pairs like USD/ZAR come from the low liquidity of the exotic currency, making it more volatile and riskier. 

Currency Pair Symbol
U.S. Dollar vs. Mexican Peso USD/MXN
U.S. Dollar vs. South African Rand USD/ZAR
Euro vs. Turkish Lira EUR/TRY
Euro vs. Russian Rouble EUR/RUB
British Pound vs. Indian Rupee GBP/INR

Commodities

Commodities are natural resources used as raw materials by industrial manufactures. 

There are three main categories: precious metals, energy, and agriculture. 

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Commodities such as gold and silver have a world market that transcends national borders, politics, religions, and race. A person may not like someone else’s religion, but he’ll accept his gold.

Robert Kiyosaki

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Precious Metals
Gold
Gold is the most traded precious metal in the world. 
A symbol of wealth and power.
Valuation reference in business and trades since ancient times. 
Used as a valuation standard for the U.S. Dollar until 1971 (“Gold Standard”). 
Gold is considered the #1 safe haven to trade when markets are risky.
Silver
Silver is another precious metal that shares similar features to gold.
A relatively lower symbol of wealth and power.
A relatively lower valuation reference in business and trades.
Have strong price correlations with Gold. 
Recently became an important raw material in Electronics and Health industries.
Copper, Platinum and Palladium
Copper, Platinum, and Palladium are other in-demand metals in the markets.
Copper is used in almost all manufacturing and construction industries.
Platinum and Palladium are rare metals used in automotive, aviation and space.

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Energy
Crude Oil
Crude Oil
Crude Oil is the #1 energy source and most popular energy commodity. Brent Oil is the European and global crude oil benchmark. West Texas Intermediate (WTI) is the American crude oil benchmark. Crude oil is among the assets with the best volatility/return proportion.  Both crude oil and its by-products (e.g., plastic) are very versatile; can be used as energy, raw material, processed material, and trade commodity. Its by-products include other financial commodities like Natural Gas, Gasoline, and Heating Oil.

Natural Gas
Natural Gas is the rising star of the energy industry. Can be collected directly from natural gas deposits or produced from shale oil. Far more cost-effective and environmentally friendly than crude oil. Easier to extract, store, process, and transport.  Aspiring to be #1 energy source as processing technologies develop.

Natural Gas

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Agriculture
Although not as popular as precious metals or energy, the ever-lasting activity in the agriculture industry creates its own demand. 
Agricultural commodities include crops and livestock, and their uses range from food and nutrients to fuel and industrial raw materials. 
Common agricultural commodities: Corn, Soybean, Coffee, Wheat, Cocoa, Sugar, Cotton.

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Stocks

Stocks are financial contracts that represent a degree of ownership in a business. 

When a company divides the ownership rights, it issues a specific number of shares.

Each shareholder receives a number of shares for on their equity (percentage) in the company. 

A stock is an aggregation of shares that are issued for trading privately or publicly. 

When a company gets listed on a stock exchange by an initial public offering (IPO), its stocks become available for buying and selling activity by the traders.

Stocks trading is especially active during quarterly earnings seasons and economic crises.

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In investing, what is comfortable is rarely profitable.

Robert Arnott

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U.S. Stocks

United States of America is the largest economy in the world, U.S. Dollar is the reserve currency of the world, and American businesses lead all industries around the world. 

Naturally, the stocks of American companies like Apple, Amazon, Google, Facebook and Microsoft, are by far the most popular among traders and investors alike. 

The largest two stock exchanges in the U.S. and in the world, New York Stock Exchange (NYSE) and Nasdaq Stock Exchange (NASDAQ) had $22.9 bn and $10.9 bn market capitalisation respectively in 2018. 

Source: Wikipedia

The collective value of these two exchanges is higher than the total market capitalisation of the next ten (3rd-12th) stock exchanges.

European Stocks

Europe is home to many royal economies like United Kingdom, Germany, France, and Italy. 

They are united politically with European Union (EU) and economically with European Economic Area (EEA), and most countries adopted Euro as the regional currency. 

The commercial dominance of Europe created conglomerates such as Royal Dutch Shell, BP, Volkswagen, AXA, and BNP Paribas. 

Each company’s stock is traded during the business hours of their stock markets. 

For example, BP of United Kingdom is traded in the London Stock Exchange (LSE), Volkswagen of Germany is traded in the Frankfurt Stock Exchange (FWB), and BNP Paribas of France is traded in the Euronext (regional stock market of EU).

Asian Stocks

Asia harbours numerous economic behemoths. 

China and Japan are 2nd and 3rd largest economies and stock exchanges in the world. 

Source: Wikipedia

India, South Korea, Australia, and Saudi Arabia are rapidly emerging as other continents struggle with economic and political issues. 

Asia has fertile lands and natural resources which fuelled growth of many mining and energy companies such as BHP and Sinopec. 

Moreover, the excessive population enabled cheap manufacturing and grew many multinational companies like Toyota, Sony, and Samsung. 

Although each company is traded in the stock exchange they are listed, Asian stocks generally follow the trends in the USA due to strong trading partnerships between two regions.

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Indices

An index is a financial basket which measures the performance of specific assets related to a market or an industry. 

They serve as a benchmark to monitor the fluctuations in the valuation of the market over time. 

Investors often use indices to understand how well their investments perform; if the return of investment (ROI) is higher than the return of index, it is considered as a good trading strategy. 

The most common index types are:

Stock Indices Currency Indices Commodity Indices
Dow Jones 30 (USA) S&P 500 (USA) NASDAQ 100 (USA) DAX 30 (Germany) FTSE 100 (UK) ASX 200 (Australia) Nikkei 225 (Japan) U.S. Dollar Index (USD)  Euro Currency Index (EUR) Invesco DB Commodity Tracking Fund (All types),  iShares S&P GSCI Commodity-Indexed Trust (Mostly energy) Bloomberg Commodity Index (All types)

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How Index Components are Chosen?

Index management board decides the component selection methodology.

Components are usually the assets which have the highest valuation in their respective markets. 

NASDAQ-100 index lists the top 100 non-Financial companies in the Nasdaq Stock Exchange. 
S&P 500 index lists to the top 500 companies traded in the New York Stock Exchange (NYSE).

Each asset has to meet certain reporting and performance criteria to remain listed in the index.

Management boards meet periodically to evaluate the performance of the constituents and rebalance the index by dropping underperforming and including high performing companies.

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How Index Value is Calculated?

Index value is based on a price calculation method which is based on 3 parameters:

Valuation Basis
Share-Weighted Index: based on the share price of each component 
Capitalisation-Weighted Index: based on the market capitalisation rankings 
Extent of Inclusion
Full Shares Adjustment: all shares issued by the company are included
Free-Floating Shares Adjustment: only publicly traded shares are included
Weighting Methodology
Equal-Weighted Index: all components have the same weight percentage
Capitalisation-Weighted Index: each component is weighted according to market capitalisation percentage in the total index value.
Modified Capitalisation-Weighted Index: a weight cap is introduced to limit the influence of high-weight companies on the overall index value.

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What Factors Affect the Index Price?

All factors which can affect stock prices can also affect the prices of indices they are listed in.

Earnings seasons, corporate tax and regulation developments, new technologies can impact.

In capitalisation-weighted indices, high-weight components have larger influence on the index value and any changes in their capitalisations can have strong impact on the index. 

Lastly, the economic events which affect the currency of the index (e.g., USD for S&P 500) can cause fluctuations in the value.  

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Cryptocurrencies

Cryptocurrencies are digital finance products which aspire to revolutionise global finance.

They decentralise monetary transactions and allow people to send money to each other without any other medium like banks or payment providers. 

This peer-to-peer nature of cryptocurrencies offers the users superfast, digitally encrypted, anonymous and low-cost financial transactions. 

Cryptocurrencies are acquired through a process called mining, during which users confirm and facilitate transactions through their computers and get rewarded with coins.

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Cryptocurrencies in the Financial Markets

Cryptocurrencies have large-scale price fluctuations due to low liquidity. 

They are high-risk / high-return assets and present many trading opportunities.

Crypto prices peaked towards the end of 2017 when the speculations in the finance media increased their popularity among regular traders. 

As a result, Bitcoin reached above $19,000 in December 2017, and carried along other altcoins to the peaks. 

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Bitcoin

Bitcoin is the predecessor of all cryptocurrencies. 

It was published as an open-source project in 2008 by Satoshi Nakamoto, whose real identity is still unknown to the day. 

Bitcoin remained relatively dormant until about 2013.

From then on, the public attention fuelled the surge in the prices of Bitcoin and other altcoins. 

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Altcoins

Altcoin means alternative coin and refers to all digital coins other than Bitcoin. 

Almost all altcoins are formed either as “forks” of Bitcoin:

When Bitcoin blockchain became too big and had to be split, or
Use Bitcoin technology as the underlying infrastructure to create a new coin.

Altcoins are traded usually against Bitcoin and their prices against fiat currencies move in correlation with Bitcoin prices. 

Some of the most popular altcoins are Ethereum, Ripple, Bitcoin Cash, Tether, and Litecoin.

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ETFs

Exchange-Traded Funds (ETFs) are investment funds which are traded in the stock exchanges. 

An investment fund usually focuses on a single industry and owns a range of assets like stocks or commodities related to that industry. 

An Oil industry ETF can comprise a portfolio with:
Commodities: Crude Oil and Brent Oil futures
Currencies: Canadian Dollar (CAD) and Saudi Riyal (SAR)
Stocks: ExxonMobil and Chevron

In order to measure the performance of their portfolio, they create a basket of their assets and monitor it as an index. 

When a fund becomes large and successful enough, they can split the ownership of the fund into shares and offer it to public trading via stock exchanges. 

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How ETFs are traded?

An ETF is traded in the same way stocks are traded. 

ETF prices fluctuate as investors buy and sell the shares of the ETF, and at the end of the trading day its value is calculated. 

Forex traders and investors trade Exchange-Traded Fund CFDs when they are interested in the performance of a specific market or an economy. 

ETFs allow avoiding high-risk exposure to buying each asset individually. 

The most popular ETFs are: SPDR S&P 500 ETF (SPY), SPDR Gold Shares ETF (GLD), and iShares MSCI Emerging Markets ETF (EEM)

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Bonds

Bonds are treasury debt securities issued by the government treasuries or private companies. 

Purchasing a bond means giving a loan in exchange for interest payments until the expiration.

The expiration of a bond can be anywhere from 3 months to 30 years. 

Long-term bonds typically have higher interest rates than short-term bonds. 

When the contract matures, the issuer pays back the initial cost and closes the contract.

Bondholders are not required to hold on to the bond until expiration. There is a secondary market where bonds and other debt securities like bills and notes can be traded.

Bonds are often regarded as the safest investment option as they have high liquidity and are backed by governments.

Most popular bonds: U.S. Treasury Notes, Euro-bund, U.K Gilts, Japanese Government Bonds. 

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