Trading basics

Trading in one sentence

Have you ever bought something and sold it on for more? A second-hand phone, a concert ticket, a pair of trainers. Then you already know the principle. Trading is nothing else, except that what changes hands is a financial instrument rather than an object, and the market stays open to millions of people at the same time.

The full definition fits on one line: trading means buying and selling a financial instrument to profit from the change in its price. Nothing in there mentions duration, and that is deliberate. A position can live forty seconds or four months without changing its nature.

The difference with investing is not a matter of seriousness, it is a matter of where the gain comes from. An investor buys an asset for what the asset produces: a dividend, a rent, a coupon, ten years of a company growing. A trader buys for the gap between two prices. Both are legitimate, they simply are not steered with the same tools or over the same horizons, and mixing them produces portfolios that obey neither logic.

Three things still separate this market from reselling a phone. The price is public and continuous, remade at every transaction. You can leave within the second, which a phone seller cannot. Finally you never meet the person on the other side, which has a consequence worth facing straight away: every time you buy, somebody sells at the same instant, at the same price, and they are every bit as convinced as you are.

That last idea carries everything else. A price is not a truth, it is the point where supply and demand agreed one instant ago. It is under no obligation to travel where your analysis would like it to go.

The two ways to make money

There are two ways to make money on a market, and the second one always surprises beginners.

The first is obvious. You buy at one price, sell higher, and keep the difference. You are then said to be a buyer, or to be long. It is what everybody pictures when markets come up in conversation.

The second works backwards. You sell first, then buy back later, cheaper. It sounds impossible, since you cannot sell what you do not own. In practice the instrument is borrowed for the duration of the operation, sold high, bought back low, returned to its owner, and the gap stays with you. That is called short selling, or being a seller, or being short.

On many modern instruments that borrowing is invisible: your broker handles all of it and “sell” is a button sitting next to “buy”. The mechanism has not disappeared for all that, it has merely been tidied out of sight, and it is paid for somewhere, in a stock lending fee or in the swap on your position.

⚠️ The two directions are not symmetrical, and the figure below shows it better than a paragraph can. When you buy, your maximum loss is known in advance: a price does not go below zero, so you cannot lose more than you committed. When you sell short, there is no ceiling above you at all. Losing more than the stake is arithmetically possible, which makes the stop and the position size even less optional than usual.

Short selling is neither immoral nor exotic, incidentally. A wheat grower selling a harvest forward before it has been cut is doing exactly that, and doing it to sleep at night rather than to speculate.

What you actually hold

Opening a position is not “buying the market”. It is entering an agreement with a counterparty about where a price goes. Depending on the instrument that agreement carries a different name, and the difference is not cosmetic: it decides what you own and who owes you what on the day you turn out to be right.

Buy a share and you hold a fraction of a company. The title is registered in your name at a custodian, it survives your intermediary going under, and nobody can take it away from you because the price fell. You also get rights that have nothing to do with the chart: a vote at the general meeting, a slice of the dividends if any are paid.

Take a position through a CFD, a contract for difference, or on a spot currency pair, and you hold nothing at all. You have a contract with your broker, who will pay you the price difference, or claim it from you. It is lawful, it is widespread, and it means that firm's solvency is part of your risk on exactly the same footing as the quality of your analysis.

A futures contract is different again: a standardised commitment, traded on an organised exchange, with a clearing house standing between buyer and seller. Nobody is anybody's counterparty, which settles the previous problem, at the cost of a margin deposit that is called and adjusted every day, sometimes several times a day.

The exercise takes five minutes and can be done tonight: open your account statement and look for how your position is named there. “Contract for difference”, “spot position”, “March futures contract”. The legal name tells you everything. If it appears nowhere, that is already information about the intermediary you picked.

The question that sorts every product

In front of any instrument, ask yourself this one, and demand an answer in a single sentence: who pays me if I am right, and what happens if that person defaults?

It ranks products far better than a performance table, because it bears on what stays true when markets go badly, which is precisely the moment tables stop being useful. A product whose answer is vague is not a complicated product, it is a product you must not take while the answer stays vague.

A second question completes the first: what happens if I can no longer sell? On a heavily traded instrument the question never arises. On an exotic product, an obscure token or the shares of a very small company, there is sometimes nobody on the other side at the moment you want out. Your position is then worth whatever someone agrees to pay for it, and that figure can sit a very long way from the last one displayed.

A third question, asked far less often, earns its place: who manufactures the price I am looking at? On an organised market it is the central book, and everybody watches the same one. At an intermediary who is its own counterparty, it is that firm, built from the flows its providers send it. Both situations exist, both are regulated, they simply are not handled in the same way.

Write your answers down. Three lines per instrument, written once and for all, beat three hours of comparison shopping: they get re-read on the day the market turns unpleasant, and that is the only day the question really counts.

The four families of markets

Shares are slices of companies, traded on venues that open and close at fixed hours. The book is central, the volume displayed is volume genuinely exchanged, and the price reacts to concrete things: quarterly results, an acquisition, a change of management. The price of that clarity is the timetable. A venue quoting for roughly thirty-five hours a week spends all the remaining time shut, while the news keeps running.

The currency market swaps one money for another, always in pairs. You never buy a currency on its own: you buy one by selling another, which is why a quote can rise because the second one weakened, without the first having moved at all. There is no central book, each intermediary builds its own price from its own providers, and the market runs continuously from Sunday evening to Friday evening.

Commodities are mostly traded through futures contracts, backed by a physical delivery almost nobody ever takes. That origin leaves two marks worth knowing. Seasonality first: gas, wheat and coffee do not live through the same year. The roll second: every contract has an expiry, staying positioned forces you onto the next expiry, at a price that is not the same one. The market is said to be in contango when the far expiry quotes above the near one, in backwardation when it quotes below, and that gap is paid or earned at every roll, outside any move in the price itself.

Crypto assets, finally, trade without interruption, weekends included, on platforms that do not coordinate with one another. Two practical consequences: there is no opening, therefore no price gap on Monday morning, but there is no moment either when the market leaves you alone. The question of who holds the assets comes on top, and it is the same question as the one in the previous section.

What genuinely separates these four families is neither their reputation nor their supposed volatility, it is the number of hours during which your position lives without you being able to act on it. The figure lays that number out flat, and it alone explains why the same stop does not protect you the same way from one market to the next: an order does not fill in a closed room.

Who takes part, and why size beats intent

The market is not populated only by people like you. Knowing who takes part, and above all under what constraints, explains a good share of what price does.

Retail traders are the largest group by headcount and the smallest by volume. They come and go whenever they please, with nobody to report to, no mandate to respect, no obligation to be invested at all. That is a real advantage, and it is the only one on this list that nobody can take away from them.

Long-term investors, pension funds and asset managers, buy for years. A five-minute candle is none of their business, but when they rebalance a portfolio the volume they shift shows. Banks deal continuously, often on behalf of clients, and part of their activity is not even directional: they hedge exposures, producing orders that no trend analysis will ever explain. Hedge funds take large positions, with varied strategies, sometimes in both directions at once.

Market makers deserve a paragraph of their own. They quote a buying price and a selling price at all times, and make no attempt to guess direction: they earn the gap between the two, thousands of times a day. The economist Harold Demsetz gave that gap its exact name as early as 1968, in The Cost of Transacting: the spread is the price of immediacy. You are not paying an entry fee, you are paying for the service of being able to buy now instead of waiting for a seller to turn up.

⚠️ None of these participants is targeting you personally, and most are unaware you exist. What to take from it is far more useful than a conspiracy theory: they carry size constraints you do not have. An order for several hundred contracts does not fit at the best price, it has to consume several levels of the book or be sliced across hours. Those constraints leave readable traces on a chart, and that is the whole subject of the structure and liquidity category.

What a round trip costs before you are even right

You pay to get in and you pay to get out. The spread is the standing gap between the price you are sold at and the price you are bought at: the second your position opens, you are already behind by that gap. Commission is added on many accounts, usually in proportion to the volume traded. Swap is charged every night on a position you keep, and it can run either way.

Swap deserves a clarification, because it catches almost everyone out. It is not an arbitrary fee: it reflects the interest rate gap between the two legs of your position. On spot currencies, where settlement happens two business days out, Wednesday night carries three days of swap instead of one, because it covers the coming weekend. A position held for several weeks therefore pays a great deal more than a single night's line would suggest.

Those three lines look trivial taken one by one, and the arithmetic says the opposite. A tenth of a per cent of friction per round trip, repeated two hundred times in a year, costs twenty per cent of the account before the word strategy has been spoken. The same method, applied ten times in a year, costs one. It is not the unit cost that changed, it is the number of times, and that is the one variable of the two you decide entirely.

Measure this cost on your account rather than in the brochure. The advertised figure is an average in calm conditions; the one that matters is the one you take at a session open or on an economic release, when the gap widens all at once and your market order lands further away than the price you were watching.

A trading journal exists for exactly this: adding up what you never see leave. Most traders discover the real weight of their costs the day somebody shows it to them on a single line, and that line often exceeds their worst trade of the year.

What trading is not

It is not gambling, because gambling offers no handle at all: you choose neither when to enter, nor the stake, nor when to stop. It is not a skill acquired in a month either. It is an activity of repeated decisions under uncertainty, in which the outcome of any single decision teaches you almost nothing.

That last sentence deserves a pause, because it runs against instinct. A winning trade can come from a bad decision that got lucky. A losing trade can come from a perfectly sound decision on which chance happened to fall the wrong way. Judging a method on five trades is judging a die on five rolls.

The figure below shows the phenomenon without a single word of market vocabulary: four runs of rolls, one and the same die. Over twenty rolls the four tell opposite stories, one of which gives a perfect impression that the die is loaded. Nothing changed in the process between the four runs, absolutely nothing.

That is why the whole programme keeps insisting on process rather than outcome. The outcome of a trade does not belong to you, it belongs to the market. The quality of the decision belongs to you entirely, it can be graded before the result is known, and it is the only thing you can deliberately improve.

The practical consequence is a harsh one: change nothing in your method until you hold a sample that means something. Fifty comparable trades, taken in comparable conditions, are a minimum, and that is already thin. Changing a rule after three losses is not adaptation, it is noise added to noise.

Where to start, and for how long

The last point of this lesson is the least followed and the highest paying: pick one instrument and stay on it for months.

Every market has its hours, its usual volatility, its own reactions to announcements, its end-of-session traps. Those are things only learnt by watching the same thing for a long time. A trader who switches instrument every fortnight restarts from scratch every fortnight: they will pile up screen hours and never pile up experience.

The choice matters less than the consistency. A heavily traded instrument whose active hours match the ones when you are genuinely available is plenty. Add one single constraint: that its smallest position size lets you risk an amount that does not stop you sleeping. A market whose smallest possible lot is already too big for your account is not your market, however interesting it may be otherwise.

Tonight's exercise fits on three lines of paper. Write the exact name of the instrument you follow. Write who pays you if you are right. Write what your last round trip cost you, spread and commission included, expressed as a percentage of the position. If any one of the three lines stays blank, you have just found your next hour of work.

The next lesson covers how to open an account and place a first order without hitting the wrong button. The one after that explains what actually moves a price, and why good news can send a market down.