A lot of people are afraid that trading on an exchange is tantamount to playing in a casino where you can only count on a sporadic win and the imminent loss of all your money in the end.

In reality, trading is a diligent handling of financial instruments. If you are doing your thing consciously, your efforts will certainly bring about a fruitful outcome.

But in case you purchase whatever comes to hand in a random order, the result will hardly make you happy.

Trading on an exchange doesn’t remind an experienced investor of scenes from Hollywood movies about adventurous, go-getting stockbrokers running all over the exchange building and concluding contracts in a heartbeat. On the contrary, it’s more like slow and well-thought-out work.

So how about we find out the secret of successful investment in securities right now? Let’s jump right in. And a fine starting point in the discovery of the world of investments is an exchange.

What is an exchange?

The modus operandi of an exchange is analogous to that of a food or clothing market. The only distinction is that they sell currency and securities instead of vegetables and attire there.

Of course, it’s a very simplistic analogy, since on present-day exchanges, trades occur electronically. And in place of regular shoppers, there are professional members of the commercial paper market: banks and brokers.

Other than that, it’s the same thing. Some members are selling, the others are buying and an exchange is watching over all of them.

Investors enter an exchange with a view to put their money to work and increase it. Businesses may enter an exchange in order to get the capital they need to expand. Banks act as intermediaries for all of them.

Thus, an exchange is a place where you can buy and sell the different kinds of securities.

By the way, anyone can become a securities investor, that is, invest into securities and make money on this. You just need to have a passport and some money to start trading.

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However, you can’t just come to an exchange, waving a banknote bundle, and start trading. The point is that an exchange only works with professional members: banks and brokers. To access trades, you need to utilize the services of one of them.

You tell an intermediary (broker) what to do with your money and securities, and they run your errands for a percentage. There are even brokers that don’t have requirements for the minimum size of deposit, which might be a big help to a first-time investor with a limited budget.

As you might know, there are different kinds of exchanges: foreign, mercantile, stock, etc.

Let’s expand on a stock exchange. If you are interested in long-term investments, you really need to take a closer look at the stock market, since securities purchased at this type of exchanges will pay off only after some time. They trade shares, bonds and other securities there.

We think it would be appropriate to say a few words about bonds at this point.

Bonds

This type of securities represents a debt instrument that enables you to collect the debt afterwards and hence generate fixed income. When some entity issues bonds, it means that it borrows money from someone and assumes an obligation to give the money back with interest after a period of time. By purchasing a bond, the amount of a refund and a repayment period of a debt for the bond are known upfront.

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In case you obtain someone else’s bond, you as though repurchase somebody’s right to collect money from the issuer of the bond.

Basically, when you buy a bond issued by the Ministry of Finance of your country for 30$, it means that you loan the money to the ministry, and now it owes you this sum. Let’s assume that after that, for some reason, you decide to resell the bond to someone.

Now it’s not you that the Ministry of Finance owes 30$ — it owes the money to the person who has bought the bond from you.

The debt instrument under consideration has an issuer, nominal cost, repayment period and coupon.

An issuer is a corporation or government that issues a bond.

Face value (nominal cost) is the amount that an issuer gives you at maturity.

Maturity (repayment period) is the time during which a corporation or government are obliged to use your money and by when they commit to give them back. (A repayment period is identical for the bonds of the same issue.)

A coupon represents an interest that is paid to a bondholder at regular intervals, similar to the payments of interest on bank deposits. A bondholder is aware of a schedule for the coupon payments upfront, since they become known at a time when bonds are issued. It’s kind of a payment for using your money.

You can purchase bonds at the time of their placement or do it when they are put on the stock market. In the latter case, you purchase bonds from someone who has bought them at the time of their placement and is now reselling them.

If you are a private investor who possesses a small amount of money, you need to opt for the second alternative.

The market price of a bond is set as a share of its nominal cost expressed as a percentage. For example, the market price of a bond may amount to 98.7%. Why 98.7% and not 100%? Because the market prices of bonds normally go up from the moment they are placed, so for the purpose of attracting a buyer, a seller has to make up for this price difference by giving the buyer a discount and hence stand out among other sellers.

In addition to paying the cost of a bond, you’ll also have to pay the seller his coupon income accrued, that is, an unpaid portion of the coupon income.

It’s also worth mentioning that besides the bonds with fixed-value coupons described above, there are also bonds with percentage-based coupons pegged to the interbank or inflation rates. Such bonds protect a buyer from shifts in percentage rate occurring in the overall economy.

Moreover, there are also amortized bonds, which are the loans in which both the principal and the interest are paid back by a borrower gradually, rather than a one-off payment at maturity.

In comparison with bank deposits, bonds are more adaptive instruments, despite being more complicated ones. Bonds enable a private investor to lock in an interest rate for a long term, increase flexibility in investing money and getting it back and get a higher return than that of bank deposits.

As concerns the safety of bonds, technically, bonds are even more secure than a bank’s deposits. But in practice, it’s a matter of the reliability of a broker from which you purchase a bond. Just as the owners of banks can steal their depositors’ money, brokers can snatch money and stocks from their clients’ accounts.

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The solution to this problem is to take the time to pick out a dependable intermediary.

Stocks

Once you acquire a stock, you acquire the status of a part owner of a business and become eligible for a share of its property and income. In other words, you become a shareholder.

Yet the company may not be profitable, be deeply in debt or even go bust. That being the case, you, being a lender, get your money back last thing. More specifically, you take higher risks than anyone else including staff members, suppliers and the company’s bondholders.

It means that in case of bankruptcy you can get nothing, and your shares will cost 0$.

Buying stocks is riskier than investing in bonds. By purchasing a share, one can expect the return of investments and income generation through a small number of schemes: receiving dividends or generating income through capitalization.

Let’s figure out what these concepts mean.

Dividend is a profit share that a company distributes to shareholders. It may be paid at the end of the year, once every 6 months, once every 3 months or in special cases. Moreover, it may not be paid at all if that is the dividend policies of a company or shareholders took such a decision on the recommendation of a board of directors.

If you have bought stocks through a broker, dividend will be transferred to your brokerage account, with no need for your supplementary actions.

It’s worth noting that shares may take on the characteristics of bonds, providing you with a regular flow of payments. This can be the case only if the issuer of your shares guarantees the stability of payments and transparency in dividend policies.

Capitalization is a rise in share prices caused by a rise in the value of a company itself.

Normally, it is startups operating in up-and-coming markets that increase in value rapidly, and due to this increase, return on stocks may be many times larger than bond yields.

As a rule, such companies don’t pay dividends, but invest all their income in the development of their business and capturing market share.

Thus, to make a profit from capitalization, you have to sell stocks at a higher price than that at which you bought them.

As long as you possess stocks that grow in prices, they don’t bring you money on their own. In order to profit from an increase in the value of shares, you have to sell them.

Forecasting future shareholder value is not an easy task. It is normally performed by investment banks. They create the models of companies and markets and try to predict future share prices.

Investment banks’ recommendations are normally available for their clients. Yet some information is made publicly available on the websites of these banks, in news feeds and in the business press.

The sources mentioned above often publish the consolidated recommendation of analysts that provide advice on the buying and selling of securities.

Nevertheless, other people’s forecasts should be treated with caution, because they provide no guarantee that the forecast proves correct. Someone else’s projections are more helpful in terms of learning than obtaining accurate information – by browsing the recommendations of analysts, you come to understand what data professionals are dealing with.

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It’s worth remembering that equity investment may be extremely risky. Anything may affect share prices starting with the activities of a company and ending with developments in the world economy, political developments in your country and even rumors.

If you want to be guaranteed that you will preserve your capital and receive a stable flow of payments, then shares shouldn’t be a key part of your investment portfolio.

Exchange-traded funds

You can also put money into exchange-traded funds (ETF). Every such fund represents a whole securities portfolio. The exchange-traded funds can be sold and bought the same way as common shares.

Analogous to a food market, obtaining funds under consideration is the same as buying a full set of products you need to make a soup, rather than purchasing beetroot, potato, meat and cabbage separately.

Acquiring ETF is easier than buying separate securities. By investing in such funds, you partially relieve yourself of the burden of maintaining your investments. For example, bond ETFs can independently reinvest coupons, instead of paying a return to a shareholder. The same goes for stock ETFs: they can reinvest your dividends.

In both cases, your equity return is factored into funds’ share prices – they increase in value by the amount of a dividend reinvestment payment.

Thanks to exchange-traded funds, you won’t have to deal with a large number of instruments, compile your individual securities portfolio and address the issues of foreign market access. It is the fund that performs all these tasks. All you need to do is buy its stocks.

The good news is that a minimum threshold required to enter stock ETFs is sometimes thousand times lower than that of stand-alone instruments from the fund’s portfolio.

Let’s take an SPDR S&P 500 ETF, which comprises the equities of major US companies, as an example. It costs, let’s say, 350$. By purchasing this fund, you invest in a whole securities portfolio, thereby diversifying risk.

But if you wanted to purchase stocks or bonds that are part of such funds independently, you would have to shell out between 100,000$ and 200,000$, and a well-diversified index portfolio would worth millions of dollars.

Thanks to the funds, you can also invest in the securities portfolios of foreign countries and make calculations in the currency of your country.

The secrets of successful investment

Now that we have become acquainted with the features of different investment instruments, we can set out the principles of fruitful investment, which are as follows:

  1. Take the time to choose a credible broker before you start putting your money into securities.
  2. Give preference to investment in bonds over investment in stocks or bank deposits. Unlike stocks, bonds ensure predictable return on investments. And as compared to bank deposits, bonds are more flexible instruments; they guarantee that an interest rate is locked in for a long term and provide a higher return than that of bank deposits.
  3. Opt for exchange-traded funds rather than stocks, since investment in ETF enables you to diversify risks, reinvest coupons and dividends and free yourself from the maintenance of your investments.

That’s pretty much all we wanted to tell you about how to trade on an exchange, and what instruments you should take a closer look at in order to work out a successful investment strategy and eventually make a fortune being an investor.

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