Before a person makes an investment, he or she should be aware of the financial market fundamentals. People tend to invest their money as a normal thing and it is an activity that is done by many people without the knowledge of the basics. People often find themselves in bad situations because of this.
This guide is intended to help people understand the basics of financial markets and it is designed to be clear and simple.
This guide is for people who are new to investing and are interested in learning about financial markets, the different types of financial markets, and learning the financial markets in a safe manner.
1. What are Financial Markets?
Financial markets are places where investors can buy and sell financial assets, and where sellers can find buyers for the assets they want to sell.
Financial assets include:
- Stocks/shares
- Bonds
- Currencies
- Commodities
- Financial derivatives
In other words, financial markets are places of social and economic activity where:
Investors- people with money
Sellers- people or businesses who are in the market for what the investor has to offer and are willing to give financial compensation for what they want.
Some examples of financial markets include the stock market in India, the bond market, and the forex market.
2. Why Are Financial Markets Important
Financial markets serve a central function in the economy. Some of the benefits include:
- Raising capital for businesses.
- Building investor wealth.
- Allocating resources efficiently.
- Supporting economic development.
Without strong financial markets that are strong, businesses would struggle to expand and people would have fewer investments to invest in.
3. Financial Markets
Before investing, it is important to know the types of financial markets.
1. Equity Market
An equity market is a market in which the shares of a company are issued and purchased.
Example: NSE and BSE in India.
2. Debt Market
Companies and governments raise funds in a debt market by selling bonds.
3. Commodity Market
Traded in this market are gold, silver, crude oil, and various agricultural products.
4. Foreign Exchange Market
It is the market for currencies such as USD, EUR, and INR.
5. Market Of Financial Derivatives
This involves the use of futures and option contracts for speculation, as well as for hedging risk.
These markets have varying returns and different risks.
4. A Simplistic Overview of Financial Markets
To understand how financial markets work, think of them as a digital marketplace. Buyers start the bidding process. Sellers put in their offers. Prices change according to supply and demand. Trades take place via an exchange.
Take the Indian stock market, for instance. The price of a share will go up when there are a lot of buyers in the market. Conversely, if there are more sellers than buyers, the price of the share will go down.
5. The Primary Market and the Secondary Market
This concept is fundamental to financial market basics.
Primary Market
- Valid securities are issued for the first time.
- E.g., Initial Public Offerings (IPOs)
- Proceeds go to the firm directly.
Secondary Market
- Valid securities are traded for the second (or multiple) times.
- E.g., buying a share from a stock exchange in India (NSE).
- Proceeds are exchanged between private investors.
- A large number of retail investors operate in the secondary market.
6. Risk and Return, the Golden Rule of Financial Markets
A single principle governs all financial markets:
- The greater the risk, the greater the reward.
- Some examples of risk and return are:
- Fixed Deposits → Low risk with an equally low return
- Bonds → Moderate risk with a moderate return
- Stocks → High risk with a potentially high return
- Knowing your appetite for risk is key to investing in financial markets.
7. Who are the Regulators in the Indian Financial System?
In India, different financial regulators are given the duty of overseeing different markets.
- SEBI- Stock market and mutual funds
- RBI- Banking and currency markets
- IRDAI- Insurance
- PFRDA- Pension funds
These financial regulators promote transparency, equity, and protection of investors.
8. What are the Financial Market Instruments?
Before investing, the basic instruments should be known.
Equity Shares
Ownership in a single company.
Bonds and Debentures
A loan given to a company or the government.
Mutual Funds
Investment portfolios that are professionally managed.
ETFs
A financial product that allows investors to buy into an index.
Derivatives
Instruments that are used for hedging and trading, but are more advanced. Mutual funds and large-cap stocks are the instruments that beginners should start with.
9. What are the Financial Markets' Common Mistakes?
Investors lose money for the first time due to avoidable mistakes:
- Investing is done without knowledge.
- Tips are followed blindly.
- Overtrading is done.
- Ignoring the process of risk management.
- Emotionally driven investments.
- Basic knowledge of the financial market would prevent such mistakes.
10. What is the Procedure to Start Investing in Financial Markets?
A simple procedure has been given for the beginners to follow.
Step 1: Financial Goals
Set the goals (short/long term).
Step 2: Risk
Understand how much volatility you can withstand.
Step 3: Start Small
To focus on a small investment, set your targets on Systematic Investment Plans (SIPs) or index funds.
Step 4: Diversify
The golden rule of investment: Don't put all your eggs in one basket, or in this case, one asset.
Step 5: Think Long Term
Remember, real wealth is built in the long haul, over time, not overnight. These steps together will help in building a systematic approach which in turn will help in making it safer as well.
Financial Markets vs Gambling (Important Difference)
This is a common misconception but investing is not gambling.
|
Investing |
Gambling |
|
Based on analysis |
Based on luck |
|
Long-term |
Short-term |
|
Risk managed |
No risk control |
|
Wealth creation |
Wealth destruction |
The difference lies in knowing how financial markets function.
Role of the Stock Market in India’s Growth
The stock market in India is crucial in many ways. It helps in:
- Providing funds for new businesses.
- Assisting the government in divesting.
- Creating financial wealth for people.
- Obtaining investment from abroad.
- A strong stock market is a reflection of the healthy growth of the economy.
Should Students Learn About Financial Markets Early?
Yes. Knowing financial markets early provides the following advantages to students:
- Discipline in managing money.
- Helps in understanding investments.
- It can prevent falling into debt traps.
- Long-term financial planning.
This is the reason financial market basics need to be incorporated into the curriculum of early schooling.
Long Term vs Short Term Investing
|
Long-Term Investing |
Short-Term Trading |
|
Lower stress |
High stress |
|
Lower cost |
High cost |
|
Better compounding |
Inconsistent returns |
If you are new to this, you should put your focus on the long-term investing side of the financial markets.
Digital Technology & Financial Markets
The impact of technology on the financial markets is significant. Consider the following examples:
- - Online trading
- - No brokerage fees
- - Real-time data
- - Open access to retail investors
Investing in financial markets has become easier than ever.
Final Thoughts on Financial Markets
If used appropriately, financial markets are excellent and effective tools for wealth creation. However, deficient knowledge of the markets entails a level of risk that outweighs the potential benefits. Contrarily, attaining disciplined education on the markets enhances the overall risk to yield better chances for one to achieve long-term financial freedom.
Conclusion
Perhaps the most important first step to becoming a successful investor is to truly understand financial markets, the various types of financial markets, and how financial markets work. This guide has highlighted the ten most important things that a beginner must know before investing.
If you focus on the fundamentals and basic principles of financial markets, if you understand how to manage risk effectively, and if you exercise patience in the markets, you will earn the opportunity for success in the financial markets.
Key Takeaway
You don’t have to know everything to get started, but you do need to know the fundamentals. Prioritise gaining knowledge before making any investments.
