In financial markets, it is important to understand the various aspects of buying and selling financial assets, the concepts of supply and demand, trading and volumes, short selling, and the various types of orders that can be used in the investment process.
First and foremost, it is essential to grasp that buying and selling do not always refer to the same thing.
Generally, buying involves acquiring a financial asset with the hope that its value will increase over time, while selling indicates the act of disposing of a financial asset, usually to make a profit or cut losses.
However, for options, let’s take a Put option as an example. It can be purchased (Buy Put) to obtain the right, but not the obligation, to sell an asset at a predetermined price within a specific date. When buying a Put, you effectively take a short position on the asset, as you benefit from its decrease in value. In other words, a Buy Put is similar to a Sell in the sense that you are betting on the asset’s price falling. This is just an example to illustrate that not all words always have the same meaning, so it is necessary to always know the tools you want to use.
Another fundamental concept is supply and demand. Demand represents the quantity of an asset that investors wish to buy at a certain price, while supply is the quantity of an asset that investors wish to sell at a certain price. The equilibrium point between supply and demand determines the market price of the asset.
To better understand the concept of supply and demand, let’s give an example:
Imagine you are in an art auction and are interested in a painting that will be auctioned. You decide to offer a price for the painting, representing your demand. At the same time, there are other participants in the auction who offer their prices, representing their demand.
If demand for the painting is high, meaning many people are interested in buying it, the price of the painting will increase because demand exceeds supply.
Conversely, if there are few people interested in the painting, the price will decrease because supply exceeds demand.
This same mechanism applies to financial markets as well. If there is high demand for a stock, for instance, the stock price will rise. If there is little interest in a stock, the price will fall. Thus, the balance between supply and demand is what determines the price of financial securities in the market.
The “bid” and “ask” are two important prices in the buying and selling process. The bid is the highest price that a buyer is willing to pay for an asset, while the ask is the lowest price at which a seller is willing to sell. The difference between the bid and ask is called the “spread” and represents the implicit cost of trading in the market.
To carry out transactions through a broker using bid and ask prices, investors can place market or limit orders. A market order is executed immediately at the best available price: buying at the ask price and selling at the bid price. For greater price control, investors can opt for limit orders, setting the maximum purchase price or the minimum selling price they are willing to accept, which may be below or above the current market price, respectively.
When an investor places a market or limit order, the ease with which these orders will be executed depends on the market’s liquidity, which is reflected by the trading volumes. A high volume indicates a strong presence of buyers and sellers, allowing orders to be executed more quickly and at prices close to the desired levels. Therefore, knowledge of trading volumes can influence an investor’s decision regarding the type of order to place and the timing of it.
Another important concept is short selling, which is an investment strategy that involves selling an asset one does not own, with the hope that the asset’s price will decrease. The investor then repurchases the asset at a lower price and returns the “borrowed” units, making a profit on the price difference.
Lastly, there are several types of orders that can be used in the investment process, including market orders, limit orders, stop orders, and take-profit orders. A stop order is used to limit losses or protect profits, while a take-profit order is used to automatically close a position when a profit target is reached.
In conclusion, the process of buying and selling financial assets is complex and requires a deep understanding of various concepts and strategies. It is crucial to familiarize oneself with the dynamics of supply and demand, bid and ask, trading and trading volumes, short selling, and the different types of orders that can be used to manage one’s investment portfolio.
