Financial Markets Explained for Dummies

What are financial markets?

Financial markets refer generally to a type of marketplace where investors and traders can trade in foreign exchange (forex), commodities, and all types of securities such as shares (stock) and bonds.

Terms regarding financial markets to be aware of

• Primary market

A primary market refers to a market where companies sell shares (ordinary and preference) and bonds to the public for the first time. Also, when a government sells government bonds, notes, and bills directly to traders and investors for the first time, those transactions occur on the primary market.

Put differently, on a primary market, securities are purchased directly from an issuer, such as a company or government.

An initial public offering (IPO) is a well-known example of a primary market.

• Secondary market

A secondary market is where investors and traders trade in securities they already own. Examples of securities traded in secondary markets are equity shares, bonds, debentures, and treasury bills.

The Johannesburg Stock Exchange (JSE) and the New York Stock Exchange (NYSE) are examples of secondary markets.

• Regulated market

A regulated market, also referred to as a controlled market, refers to a market that is regulated by a government or an established public authority, exercising some degree of oversight.

• Centralised market

A centralised market is a specialised financial market devoid of competing markets.

Among others, centralised markets comprise the following features:

• All orders (purchases and sales) are directed through one central exchange.
• The pricing of securities is totally transparent and open to anyone to see.
• Security prices are the only prices available to investors and traders who intend to trade particular securities on the specific market.
• Keep trades fair and expedite trading processes.

The Johannesburg Stock Exchange (JSE) and the New York Stock Exchange (NYSE) are also examples of centralised markets. The London Metal Exchange is a centralised market for gold.

• Decentralised market

A decentralised market is the opposite of a centralised market. In a decentralised market, investors and traders utilise digital technology to trade, dealing directly with each other instead of trading via a centralised exchange.

The competition in a decentralised market enables buyers and sellers to choose the best deals.

The foreign exchange (forex) market is a typical example of a decentralised market because it does not operate in one physical location.

• Over the counter (OTC) market

An over the counter (OTC) market is a decentralised market in which brokers and dealers are negotiating buy and sell prices directly, without a central exchange. Hence, in OTC trading, a trader or investor will usually see two prices listed: a single buy price, and a single sell price for a currency pair or security.

Trading in OTC markets is less regulated than trading in centralised markets, creating a wide range of opportunities but also some trading risks.

The best-known and most popular OTC market is the foreign exchange (forex) market. Derivatives, such as forward contracts and swaps are also traded in OTC markets.

• Spot market

A spot market refers to a financial market in which financial instruments such as commodities, securities, and currencies are sold with the intention of being delivered to the purchaser, either immediately or within a few days.

The price of a security or commodity sold in a spot market is referred to as the spot price.

• Futures market

A futures market is a financial market in which commodity and futures contracts for delivery on a specified date in the future are bought and sold.

A futures contract is an exchange-traded derivative contract, deriving its value from an underlying asset that is listed on a trading exchange. In a futures contract the future delivery of the underlying asset, such as a commodity or security, is locked in at a predetermined price.

Types of financial markets

Stock market

Stock markets, also known as stock exchanges, are equity markets in which shares[1] (stock) of a public traded company are purchased and sold by investors and traders. Share trading can generate profits for investors but can also cause incurred losses.

Shares are traded in various financial markets such as primary markets, secondary markets, and over the counter (OTC) markets. Most trading of the shares of companies is done via regulated stock exchanges (stock markets).

Participants in stock markets include, inter alia:

• Investors and traders (retail and institutional).
• Market makers (MMs), often called liquidity providers, are traders who trade high volumes of securities, providing liquidity to the market.
• Brokers who are acting as third parties, facilitating trades between purchasers and sellers but not taking an actual position on a company’s shares.

Bond market

A bond market is a type of financial market in which governments, companies, corporations, and municipalities issue bonds[2] to investors to raise large amounts of capital.

Bonds traded via a bond market are differentiated by the issuer and can be categorised into treasury bonds (governments), municipal bonds (municipalities), and corporate bonds (corporations).

Forex market

The forex market, also referred to as the foreign exchange market or currency market is a decentralised financial market. It is the largest and most liquid financial market in the world, trading about 6,5 trillion US dollars daily.

It is a financial market in which participants are allowed to execute forex trading[3], including buying, selling, hedging, and speculating on the exchange rates between currency pairs (the quotation of two different national currencies).

The currencies most traded in the forex market are called the seven major currency pairs, namely: The Euro/US Dollar (EUR/USD), the British Pound/US Dollar (GBP/USD), the US Dollar/Japanese Yen (USD/JPY), the US Dollar/Canadian Dollar (USD/CAD), the Australian Dollar/US Dollar (AUD/USD), the US Dollar/Swiss Franc (USD/CHF), the New Zealand Dollar/US Dollar (NZD/USD).

Commodities market

Commodities markets are financial markets where traders, investors, producers, and consumers buy and sell different types of physical commodities[4], also called natural resources such as:

• Hard commodities, categorised into:
• Energy commodities: Such as crude oil, coal, carbon credits, and natural gas.
• Metal commodities: Include precious metals such as gold, platinum, and silver, as well as base metals like copper, aluminium, and zinc.
• Soft commodities, classified as:
• Agricultural commodities: Include, among others, wheat, cotton, corn, sugar, rice, and coffee beans.
• Livestock commodities: For instance, livestock such as cattle, sheep, and pigs, as well as meat commodities like pork bellies.

Commodities are traded in spot markets as well as in futures markets, where commodities are utilised as the underlying assets.

Many investors and traders only trade in commodities to generate profits, having no intention of physically receiving the particular commodity, such as coffee beans or pork bellies.

Gold is an important commodity that is used as a hedge against inflation and as a safe haven during difficult financial situations and crises, such as during the early stage of the Covid-19 pandemic in 2025.

Oil is a commodity that has a major impact on the economies of countries. The price of oil is determined by the commodities futures market. A rise in the oil price impacts the cost of transportation, food prices, to name but a few.

Further, commodities are traded in over the counter (OTC) markets and in commodities exchanges over the world. For example:

(1) SAFEX is the futures exchange subsidiary of JSE Limited, the Johannesburg-based exchange.

Derivatives market

A derivatives market involves derivatives, contracts whose value is based on an underlying asset, like security, or a commodity.

Put in other words, derivatives are referred to as secondary securities because their values are derived from the primary security (the underlying asset) they are linked to. In itself, a derivative has no value.

Examples of underlying assets are currencies, bonds, commodities, interest rates, stock exchange indexes, and company shares.

Commonly, derivatives include the following types:

• Futures contracts – Refer to ‘Futures market’ above for a definition.
• Forwards are customised contracts between two parties to purchase or sell an underlying asset at a predetermined price on a specified date in the future.
• Options refer to financial derivatives that allow buyers the right, but not the obligation, to buy or sell an underlying asset at a specified price on a future date.
• Swaps are derivative contracts in which it is agreed that one party exchanges (‘swaps’) the value of one asset for another at a predetermined time.

There are four types of participants in a derivatives market, namely:

• Arbitrageurs are traders who make use of the differences in the price of a given security to generate profits by simultaneously buying and selling the particular security.

• Speculators are the risk-takers in the derivatives market, taking on risk in order to generate profits. 

• Hedgers are risk averse, trading in derivatives markets to secure their investment portfolio against market risks and price volatility.

• Margin traders utilise margin, borrowing money from a broker or brokerage to by securities or currencies.

Some functions of financial markets

Financial markets are important role players in finance and economies, performing various functions, such as:

Provide access to capital

Financial markets provide capital for individuals, governments, corporations, and companies in order to, inter alia, expand operations, cover debt, and invest. This is typically done through the stock and bond markets.

Allow businesses to offset risk

Financial markets help businesses to offset risk through the commodities market and derivatives market.

Price determination

The prices at which financial instruments are traded in the financial markets are determined by the supply of and demand for the securities, commodities, and currencies.

Financial markets provide an open and transparent way to establish prices on the financial instruments traded, reflecting all available information about all the instruments traded. Put differently, all the information about the particular security is already included in the price.

Provide liquidity

The magnitude of financial markets provides liquidity, meaning investors or traders can sell their securities anytime during trading hours whenever they need to raise cash.

Reduce the cost of transactions

Typically, a trader or investor requires various types of information in order to trade responsibly and wisely.

In financial markets, investors and traders can acquire various types of information regarding securities, commodities, and currencies without the need to spend any money.

Satisfy requirements

Companies require investors for acquiring capital and investors require the companies for investing their money and earning returns from the investments.

Financial markets serve as the platform where the needs of companies and investors are met, providing potential buyers and sellers.

Capital formation

Financial markets channel investments and savings of investors in a country, supporting the capital formation of the country.

Provide environments of fair and proper treatment

Financial markets are environments where investors and traders, regardless of the size of their trades, will receive fair and proper treatment.

[1] See the articles, ‘A General Overview of Public Company Shares in South Africa’ and ‘Ordinary Shares Explained,’ for more detail about shares.

[2] Refer the article, ‘Bond Trading – Explained for Dummies,’ for a detailed explanation of bonds.

[3] See the article, ‘Forex Analysis in Forex Trading Explained for Dummies,’ for more information about forex trading.

[4] The article, ‘Commodities Explained for Dummies,’ has more detail about commodities.