How does Trading Work

We will use this page to explore the trading business - for newcomers to the world of trading..

Introduction

The easiest way to understand this is to think about any other trading business. You are buying firewood from your friend on the farm, transport it home, put up an advertisement on the pavement and sell it to people looking for wood to 'braai' or for their fireplace in winter. The commodity, or the instument, in which you trade is firewood. You buy it someplace- the farm. You buy it from someone (the farmer) and sell it to someone else (people looking for firewood). Selling price minus cost price minus costs (transport, advertising) is your profit. You've got a trading business.

The commodity we trade in may be gold, or a currency pair (Forex). We buy it from the Exchange, the person whom we buy it from or whom we are selling to are unknown to us, someone at the Exchange. The price at which we sold minus at which we bought minus costs (brokerage charges) is our profit. We've got a trading business.

There is not much difference between your business and our business, we both got our challenges. Our's is a bit more convenient for us - we stay at home, are able to do it off our mobile devices, don't have to worry about customers or customer complaints, quality control etc., we do not have people working for us or advertising or worries about sales and other stuff...but in essence, it is the same thing

Overview

There are three role players in this business, the Exchange, the Broker and yourself. You interact with the Broker who interacts with the Exchange. The Broker will charge you a fee for his services, the only other costs that you will have is those you incur to make your decisions (books or training courses, software you may buy). Thus you have a fixed cost, or startup cost element (investment in knowledge, learn how to make a success out of it, software to assist you in making decisions, etc.) and your running cost element, which will be your brokerage charges and is incurred for every transaction that you execute

Some people, most people actually, choose to not incur the startup cost element - to not invest in the necessary knowledge or stuff to assist them in their business. That is somehting that only you can decide. The success rate of those that do invest is much higher than those that chose to do without, but it still is a decision only you can take. We of course hope that you will look at what we are presenting and consider it.

Role Players

The Exchange

The Exchange is the most important. All products that you can think of trading in are available through an Exchange. They regulate the entire business (collection of and delivery of physical product, all contractual agreements, agreements with buyers and sellers of product, collect and publish price information, they provide the physical space where trading occurs (pit trading), electronic exchange of information, etc. etc.)

There are numerous Exchanges throughout the world on which you may trade, depending on what product you are interested in trading. The JSE (Johannesburg Stock Exchange) makes it possible for you to trade in stocks (shares) of all listed South African companies. The New York Stock Exchange (NYSE or ICE) offers you US bonds and stocks, but also commodities such as Crude Oil, Gasoline, Gold. Through the Chicago Board of Trade (CBOT) you may trade in agricultural products (Corn, Wheat, Soybeans, or Cattle, Hogs), etc.

You have to decide what product you are interested in trading - based on what do you want to start your business - then sign up to the relevant Exchange. You may sign up to multiple Exchanges, it is all up to you.

Which Exchanges are we trading on? We are trading the commodities markets, but the US commodities markets (Forex is a sub-class of the commodities, so yes we are trading in Forex as well). We trade on the New York Stock Exchange (ICE), the New York Mercantile Exchcange (NYME), Chicago Board of Trade (CBOT & ECBOT) and the Chicago Mercantile Exchange (CME GLOBEX))

Broker

The Exchange is a highly regulated environment and typically do not allow you as client to interface with them directly (because of all the legal issues). Remember that the physical amount of resource (whether it shares, foreign currency (notes) or physical stuff, oil, cattle, etc.) that changes hands every day is huge - they do not have the time or resources to deal with you and your tiny little contract. Therefor, they have agreements with Brokerage Houses who provide the interface between the multitude of Traders worldwide and the Exchange. The Brokerage Houses have the necessary legal processes in place with the Exchange and they are able to route orders through the necessary channels for them to execute on the Exchange.

This is the service that your Broker provides. He has the necessary legal agreements with the Exchange and he routes your orders through to the Exchange, ensuring that all legal procedures are met, etc.

The Broker is the party that cares about you, the party that will look after you, that will ensure you are able to communicate with him and he with you. He is the one that collects your orders and routes them through to the Exchange in a timely manner. He will do everything in his power to make you happy and to ensure you receive only the best (information about the markets, price information on all products, access to market data, access to market research, analysis tools, software, an electronic interface to communicate your trades with him, a web interface, a mobile interface, international 24/7 telephonic assistance, etc. etc.)

Your broker is your friend, he is on your side, he has your best interests at heart. He will charge a fee for his services, you should gladly pay that fee if you think of everything he has put in place for you to make your experience as smooth as possible.

Unfortunately, as in any big business, there are some unscrupulous characters out there. For example you get Brokers who also trade for their own accounts and it sometimes is very difficult to draw the line. Of course the Broker has got access to priviliged information - you will never know when (or if) he is routing your transactions to his own account for personal benefit - in other words he is trading his account against yours. It is important that you do choose your Broker carefully. If you work via us, we will refer you to a trustworthy Broker. You of course do not have to make use of him, you can use any Broker you like.

Trading Account

Of course, in order to trade, you need a trading account. This is one of the services that your Broker will provide. You will need to open a trading account with the Broker and once it is open, fund that account. The Broker will require a certain minimum amount of money that you need to fund it with, it depends from Broker to Broker. It also depends on the type of market that you want to trade in - when you have studied the markets page you would have learned about margin and how the margin account worked. You have to have enough funds in your account to pay the margin for the transactions you want to enter and in addition provide some floating cash balance

You

That leaves you. Through your Broker you now have access to Trading Software, a price data feed, the means to enter and exit your transactions. What more do you need? You need to understand the markets, you need a strategy to decide when to buy and when to sell and you need a money management strategy. These you have to provide for yourself.

We can assist you with understanding and analysing the markets, how to select a market to trade in, show you how to ensure the probability works in your favour, teach you how to plan a trade beforehand, how to execute that plan and how to manage the position once you are into the market. View our Options Matrix Plus proposal for more details.

Understanding the Market

In your firewood business the price of the wood was determined by you, (and to some extend by what the farmer charged you for the wood). What determines the price of the "thing" you trade with in the market?

You can take any market, a foreign currency, a CFD on a share, Crude Oil, or Lumber - yes lumber, wood, you can trade in that. So let's take Lumber. The last price that a Lumber contract traded at was $250.00. Now let's take thousands of buyers of lumber and thousands of sellers of lumber, throw then all together and say go - trade! Some buyers will start with low prices and take a chance, prices will range up to maybe above $250. On the sellers side something similar will happen, prices will range from quite high till somewhere below $250. Where prices overlap, buyers and sellers will come together and exchange contracts, but at some point we will reach an equilibrium, a standoff between buyers and sellers. The sellers will position themselves above the last price and the buyers will position below the last price. This standoff is depicted on the picture on the left. The last price was $250. There are sellers willing to sell if the price increases and buyers willing to buy at a lower price. The columns show you the number of buyers and seller willing to trade at the price indicated. We have reached a stalemate situation.

We now enter this position with a person that says to his broker: "..buy me 850 contracts of Lumber, I don't care at what price, just buy me 850 contracts.."! This order will "consume" our sellers, we first buy 34 contracts from the guys willing to sell at $250.50, then 629 contracts at $251.00, then 174 contracts at $251.50 and then the remainder at $252.00. If nothing else changes in the market, we now have a new equilibrium, a new stand-off point between buyers and sellers. The new stand-off point is around a price of $251.50. The result is that the price for Lumber has increased! And this is what will happen, there will be a continuous influx of buyers and sellers in our market and the relative forcefullness (supply and demand) is going to push the prices up or down throughout the day until the market closes!

The Exchange records every single transaction that takes place in this market throughout the day, every day. This data is available and through the Broker's software he will make this information available to you. You get the information for the day in the format shown on the left. It shows you with a little horizontal line the price where the market opened, through the day the highest price it reached, the lowest price it reached and where the market closed, the last transation for the day (which is the price where you can expect the market to open again on the next trading day - note, might only be after the weekend if this was on a Friday). You can imagine for youself from the pictures above how the market has jumped up and down all over the place inside that vertical line on the mood swings of the traders in the market and as new traders or large batches of orders on both sides came in through the day.

Here is the total picture for Lumber. This is a daily chart. Each of those bars on the chart represents one trading day. From looking at the bars you can see what the price of lumber did every day, day after day. But the exchange does record every transaction, every second. Thus, if you want to, you could through your Broker request the data on an hourly basis, then each bar you see on the chart you will get will be 1 hour - the open for the hour, the movement through that hour represented by the vertical bar with its high point and low point and the close for the hour. You can get it for every 5 sec, 10 sec, 1 min, 5 min, 30 min - any time frame that you would like.

How do you trade?

You now have all the information you need. You have, through your Broker, setup a relationship with the Exchange and they will accept orders from you. You have an account and it is funded. Through your Broker you get all the price data and can see what is happening. You have, again through your Broker, access to software to plot price movement, tools to plot indicators and analyze your data, you can route your orders via the Broker, you can monitor what is happening.

Now it is simply a matter that you select the instrument that you want to trade in, you draw its data, you analyse the data and decide for yourself whether the price will go up or down or stay level. If you think prices will move up, you may send an order through your software to your Broker to buy the instument. The Broker will route the order to the Exchange and notify you when you have entered the market. From now on, for every price tick that the market moves, you will see the profit / loss of your position reflect in your account. You now need to decide when to exit the position, send the order to the Broker and you are neutral again in the market. The profit / loss you make determines your future.

It is as simple as that. If you get it right you can make substantial profit and grow the money in your account. If you get it wrong you can take a substantial loss. If you follow our methods you can change the probability of winning into your favor.

Good Luck with your trading!!