Share Trading Frequently Asked Questions

Questions about Shares and Stocks

Shares are units of ownership in limited companies. They are a mechanism to enable investors to finance companies and benefit from the security of ownership in the form of equity. Shares are essentially bundles of rights which attach to the owner, giving the shareholder the ability to vote on crucial strategic decisions and the right to a share of company profits proportional to the percentage of the company they own. In practice, shares are issued by companies primarily to raise capital from private investors, and sold on a secondary market by price speculators and institutional investors allowing traders to profit from fluctuating prices.

Companies issue shares as a means of raising capital for various business purposes. As a company in need of funding, the private markets pose an often more advantageous means of raising capital, with no interest or marginal costs to pay. Because shares are a proportion of ownership, they provide sufficient security for investors to buy in on often much more favourable terms than loan funding, and provide original owners and founders with the ideal opportunity to reduce their holding in the business. Companies can only issue a limited number of shares, depending on their available capital, before any further issues dilute the holdings of existing shareholders.

Shares are traded by a number of different individuals and organisations. By far, the largest volumes of shares are traded by institutional investors. These are the pension funds, insurance funds, banks and other large investment institutions which trade the markets in order to generate a return for their policyholders and investors. Institutional investors deploy expert traders and resources to analyse and research the markets, and they buy and sell in such volumes that their activity most directly shows in the trend of a market. Shares are also traded by smaller funds and even individual investors who are looking for a better return on their capital, offering those self-managing assets the chance to profit from shrewd investment.

Shares are traded is large volumes on stock markets worldwide, and provide an opportunity for private individuals to invest and trade on the performance of companies. Shares are traded because they deliver both the opportunity to profit from price speculation and an ongoing yield in the form of a dividend, allowing traders to make capital gains as well as revenue yields. Shares inherently have a value representing the value of the unitary share of company profits, so they are ideal instruments for primary and secondary traders alike.

Shareholders are the de facto owners of publicly traded companies. The shareholders are the ultimate judge and jury as far as the company direction is concerned, and the forum for decision making the company's Annual General Meeting of shareholders. As a shareholder, you have a responsibility in ensuring you uphold the interests of the company and directly your own interests by voting accordingly on the issues put to the vote, including most notably the appointment of the board and the determination of their salaries. While shareholders can choose to play a more or less participative role, it is the responsibility of shareholders as a class to have this input.

As far as the rights of the shareholder are concerned, these are primarily broken down into the right to a dividend payment, a share of company profits, and the right to have a say in the way in which the company is directed. These mechanisms jointly make shares a fantastic means by which companies can be bought and sold.

There are broadly two different types of shares which are traded: ordinary shares and preference shares. Ordinary shares are shares as they are traditionally considered. That is, a share of the profits and ownership of the company proportionate to the size of the company's total capital. Ordinary shares give shareholders the right to a discretionary dividend, where the board elects to pay some profits out to shareholders, and give a unit of voting influence for each share owned.

The second type of share is known as a preference share. Preference shares are paid a dividend at a set percentage annually in preference to ordinary shareholders, who come further down the payment chain with no guarantees or fixed dividend expectations. Preference shares tend to provide a higher yield but do not carry the same voting rights and influence as ordinary shares.

A dividend is a discretionary payment of profits proposed by the board of directors to the shareholders. Over a trading year, all listed companies aim to make a profit. Profit can be used to fuel company growth, to pay off debts, to save for a rainy day or invest in new infrastructure. Or it could be distributed to the respective owners of the company - i.e. the shareholders. This is known as a dividend, and is considered to be the yield on investment for traders before any capital growth is taken into account. On ordinary shares, which are by far the most commonly traded, a dividend payment is not usually guaranteed.

The amount of dividend declared and paid on shares varies dramatically by company to company, and there are a number of complicated variables that go in to working out how much you can expect. Dividend payments are expressed as a per share amount, and depending on the number of shares you own you can expect a multiple payment. Bear in mind that some companies declare interim and final dividends, paying out in two stages to provide two yield opportunities for shareholders throughout the year.

There is no guarantee you will receive a dividend in normal circumstances. Some companies declare dividends more regularly than others, depending on their immediate objectives and the will of the shareholders, so it really does vary from share to share. If you want to guarantee a return on your investment in shares, you would perhaps be best advised to consider trading in preference shares, which offer a set, guaranteed return for shareholders annually - even if the company decides not to declare an ordinary dividend at all.

The advantages of holding shares depend on your objectives. If you are trading purely for short-term profit, shares provide an opportunity to access the markets and trade in company stocks. Traded effectively, shares can deliver a much higher return on capital than anything available on the high street, including both an ongoing yield and capital growth as prices and markets rise. Additionally, shares allow investors a degree of influence and control that is not associated with other instruments, allowing them at certain levels to shape the performance of the company (or, to put it another way, asset) in which they are investing.

Shares can be traded at will in either direction, assuming that the company is listed on a stock exchange. Shares are standardised for this very purpose, and the company gets no say in who can or cannot own shares in it. It is important to note that while you might execute your trading decision at will when you feel your shares have reached the right price, low liquidity markets may mean that prices tail away before your order is processed. It pays to remember that more heavily traded markets are likely to deliver more instantaneous fulfilment of orders, which consequently limits this potential market risk.

You are not limited, on a practical scale, as to how many shares you can buy. A company can only sell its total capital without the shareholders agreeing to dilute their equity further, and when you start to get into tangible percentages of ownership you can quickly trigger compulsory takeover offers and other mechanisms designed to make shares a better vehicle for corporate manoeuvring. However, while there are set thresholds of ownership in companies investors will be looking to remain within, for the purposes of most individual investors the only limit to their portfolio is the capital available to them.

Shares are priced by the market, and reflect the current market value for a share at any given moment. As a share is bought, the price of those shares rises incrementally. Similarly, as a share is sold, the price of the share and the share market falls by the increment of the sale, thus the share price at any particular time is reflective of the intersection between shares being bought and shares being sold. This is the definition of market price, and given the liquidity of the share markets, traders can be satisfied that the price produced by the market is reflective of the going market rate - whether or not that price is in fact over or underestimating the true inherent value of the share.

An asset is an object of value for a company, and the easiest way of determining a company's value. If a company owns a property at £1,00,000, a fleet of vehicles at £250,000 and has cash in the bank of £500,000, its total asset value is £1,750,000. At a basic level, shareholders own a proportional share of the company's asset base, thus it can be determined whether a share is factually under or overpriced in consideration of its asset value on the balance sheet. In successful companies, asset value is only one component in determining whether a share is priced correctly.

Shares that are underpriced are technically an anomaly, and in most circumstances the markets act to correct pricing discrepancies with swift effectiveness. If a share is seen as being too cheap, investors who are constantly scouring the markets to identify profitable opportunities buy in, safe in the knowledge that they are getting a good deal.

This has the effect of starting an upwards corrective trend, which will continue until a stage where investors feel they need to sell to maximise their returns. At this point, shares will tend to become too expensive, and the market will act accordingly to correct the price. This constant cyclical motion sees markets bid up and down around the actual inherent value of stocks, and can provide an array of trading opportunities for keen-eyed traders.

If shares become too expensive, they have by definition risen in price to a point where the market feels it no longer represents a fair level for investors looking to get a return. Those that have bought at the top of a price curve are not likely to see much capital growth and may even experience a capital loss, and prices at this level are often too expensive for those investing for purely commercial reasons.

This means that prices have to fall in order for shares to be sold, and prices trend towards a more easily stomached price. The share pricing mechanism is elegant and fluid, and gives a fair portrayal of the market value for a share at any time. When this market value moves away from reality, those participating in the markets are quick to engage in correcting the anomaly.

Shareholders are liable to a certain extent for the debts of their company, but this liability is usually strictly limited. As a shareholder, you pay in your capital in return for shares, and your liability is limited to the value of your shares at any one time. Shareholders are only liable to zero in the event of company insolvency - in this respect, companies are limited in liability.

However, in the event where shareholders have a more direct influence on company trading decisions, for example in much smaller organisations where shareholders may also be involved in the day to day operations of the business, there may be some circumstances in which shareholders render themselves liable beyond their paid up capital, although for most practical purposes investors will be exculpated from lasting liability.

A share price is comprised of the value of the share and a premium which reflects the actual value of the share as a unit. When companies issue shares, they tend to do so at a set rate representing an equal division of their capital. Generally, this tends to be expressed in £1.00 denominations, for example £50,000 worth of capital divided into 50,000 £1.00 shares. This is known as the nominal price.

After these shares have been traded, they may well fluctuate wildly in value, meaning that what one investor has paid may be less than what another has paid for a similar equity share. Regardless of the total price paid for a share, the nominal price always remains as a constant, and the basis for determining the percentage share of ownership attached to each share.

The share premium is the portion of a share price that fluctuates with market pressures, and enables speculators to profit from the markets. A share's nominal value represents its fixed capital value as a proportion of the company's total capital, but often the right to a unitary share is worth far in excess of the amount of capital attached. This is known as the share premium, and is a premium on top of a shares nominal price that represents the true financial value of the share, factoring in good will, potential and future earnings.

Shares are traded on stock markets through stock exchanges. Stock markets are public forums for trading in company securities, derivatives and other instruments which enable buyers and sellers to trade standardized, common instruments and allow companies access to private capital investment. Stock exchanges facilitate trading and structure access to the less tangible stock markets, allowing private traders through their broker platforms access to shares and other tradable instruments.

Shares are traded around the world, with most developed economies housing at least one stock exchange. The stock markets play a vital role in financing economic growth and keeping the wheels of business turning, and as such they are a common feature of the global economy, with financial centres worldwide.

Shares are traded through a broker, usually online although sometimes providing telephone trading services. The rise in Internet technologies has made it possible for traders to engage with the markets more directly through online trading platforms, allowing them full control and discretion over the trading decisions through an online broker interface, which in turn executes trading orders for broadly lower trading commissions.

Most commonly, individuals investing in shares do so through funds and asset management channels, with a healthy percentage of the population subscribed to policies which benefit from returns from share trading. However, a growing number of individuals with capital to invest are choosing to self-managed their investments, and trade shares online through the new breed of low cost, 'virtual' brokers.

Shares cost money, and traders are required to take into account both the share price and the associated costs and charges that apply. The share price is made up of the share's nominal price plus the premium that represents market price, and depending on the extent of the capital deployed these costs can be significant. When shares are sold, there may be a Stamp Duty tax liability of 0.5% payable, an unavoidable tax applicable to share transactions in the UK. Additionally, brokers usually charge a commission or a transaction fee, and any leverage or financed portion will attract further financing costs which must be factored into the equation.

When dealing in shares, it tends to be the case that investors build up a number of positions to strengthen and solidify their exposure to the markets and the returns they can expect. This process of owning multiple different share prices is known as the portfolio, and is the basis on which traders can generate capital returns. A portfolio is often best kept as diverse as possible in order to spread the risks as thinly as possible, and should be protected from capital damage at all times as the 'golden goose' capital that will continue to earn money and generate a return over time.

What are the advantages of trading a diverse portfolio?

Professional portfolio managers exercise great caution in ensuring they have diversity and a broad portfolio. While broadening a portfolio may be more work, and may mean tying up more capital for less short-term gains, the advantages of diversity in trading come in the form of risk reduction and reliability. One position going bankrupt in the blink of an eye is unlikely, but it does happen. If this represents 10% of your portfolio, you're probably going to feel the pain of a 10% capital loss. If this represents less than 0.5% of your portfolio, your capital is more isolated from the damage. More frequent, lighter positions will be less risky than fewer, heavier trades, and diversification as far as possible enables traders to spread the risks and revenue streams to reinforce their capital.

Stock Markets and Exchanges

A market is a collection of buyers and sellers, facilitated by a stock exchange, which enables the determination of price for assets, e.g. company securities. In the share trading context, a stock market is where share prices are set, and where the organic supply and demand for shares can play out in primary and secondary markets. Market prices are often seen as an indicator of business and investor optimism, and healthy market levels can indicate strong investment in an economy or sector. As a result, the markets are regarded as an important economic indicator, in addition to providing an opportunity for traders and investors to generate a return on their capital.

A stock exchange is the physical front to stock markets. Whereas stock markets are notional forums for trading, stock exchanges are the facilitators of stock markets and share trading, acting as a middle man for executing share transactions.

Share brokers online and offline submit orders to the stock exchange for execution, and the stock exchange remains the only direct portal to the stock markets. In their regulatory role, stock exchanges are responsible for ensuring that shares are standardized and legitimized, and that markets are made effectively to ensure smooth, free-flowing trade. In this respect, the stock exchange is the administrative and organizational hub of stock market trading in any given territory, and holds and maintains the listings from companies submitted for public trading.

Stock exchanges work by correlating listings of publicly traded companies, and through providing an avenue for brokers to access the markets and trade with companies and other investors. Firstly, stock exchanges will require companies to adhere to specific listing criteria in order to consider their listing, and traders can rest assured in the knowledge that listed companies are vetted before being opened to the public markets to ensure they meet the legislative listing criteria. The stock exchange then ensures shares that are being traded are standardized, before opening up access to buyers and sellers with various different motivations and sources of capital. The stock exchange performs an ongoing regulatory function in ensuring the markets run smoothly and transactions are executed as required.

An index is a notional market, made up of a collection of shares which is designed to represent some broader picture and allow easy comparison with previous performance. Indices pool and average company performance, taking into account any relevant waiting considerations, to give a headline trading figure which traders often use as a gauge of how well the markets are performing. Consider, for example, the FTSE100. The FTSE100, which is comprised of shares of 100 of some of the biggest companies in the UK, is an index used to gauge how trading across different sectors is performing. Buoyant trading levels tend to show strong economic performance, whereas poor trading outcomes may reflect waning optimism and even pessimism from the markets. The FTSE100 is notional because it doesn't exist as a separate market - it is merely an index taken from the weighted average of trading levels across the sample of shares it examines.

Markets are the intersection of buyers and sellers for a security, and are given life whenever there is demand for a scarce object. In the instance of shares, markets are created when shares are first issued by a company, as an invitation to those with private capital to invest in that business. These shares then have a resell price where there is sufficient demand for them, and traders can choose to buy and sell them freely at all times. Usually, because shares are of a finite number, buy orders have to be filled with a trader looking to sell, and likewise in reverse.

Without the ability to buy and sell when required, markets would grind to a halt. This is where so-called 'market makers' come in - large funds which invest in the markets and provide a guarantee to match orders where possible to ensure the liquidity of the markets on the whole. Generally, markets are heavily traded, particularly for larger stocks, ensuring more than sufficient liquidity for most traders' needs.

Share markets are accessed most directly by trading through an online brokerage platform. Shares must be executed through a broker, which then submits orders to the stock exchange. Those that trade shares directly and manage their own investments are in a growing minority, and most investors have their capital managed by professional share traders. Those who have pensions or insurance policies are indirectly exposed to the share markets, with funds managing large proportions of some of the country's biggest companies. These firms, along with small private asset management funds, aim to generate a return on the capital they manage by trading in the share markets, and as a result have significant influence on how share market prices develop.

Markets are priced as a direct reflection of the demand for a security at any given time. They show a market price, and are influenced by factors which might suggest a rise in value or a pricing discrepancy. In general terms, markets are bid up incrementally when shares are bought, and sold down as traders liquidate their positions, but the reasons for these trends can be many and varied. In many instances, these occur because an asset is clearly under or overpriced, which causes investors to buy into or heavily exit a market. In other circumstances, bad economic news or a poor set of accounts from a key market player are amongst other circumstances which can have a significant influence on markets and how investors are influenced.

Supply and demand are fundamental economic concepts which have a direct bearing on share pricing. When a share is being bought, it is by virtue in greater demand than normal. Because the demand for shares is increasing, the price buyers are willing to pay naturally increases as the asset becomes more scarce. On the flip side, where there is excess supply in the market, i.e. where large institutional investors sell large stakes in companies which flood the market with shares, prices will fall because there are more shares in circulation. The effects of supply and demand underpin the functioning of the markets, and play a critical role in understanding whether prices will rise or fall in a given market.

Investors tend to research markets in great depth in order to identify potential investment opportunities. In order to trade successfully, keeping abreast of market developments and being knowledgeable about the markets in which you invest is critical to giving you the best chance of success. Traders tend to research the markets through media channels, and through reading company news and periodic reports. Another major element of market research many traders find helpful is technical analysis - the study of pricing data expressed visually through charts to identify trend and high and low trading levels. Most traders use a combination of current affairs and market research alongside technical analysis to identify the optimum opportunities for trading profitably.

The function of the markets can be explained perfectly with an understanding of rudimentary economics, and the link between macro and microeconomic factors on share prices should never be underestimated. The demand and supply at play within individual financial markets displays elegant pure market theory in operation, and the operation of these markets is dependent largely on the macroeconomic environment in which they operate. As a result, traders should look to become familiar with the fundamentals of economics and market theory, in addition to keeping abreast of the ongoing macro economic picture.

In order for a company to list on a stock exchange they must first submit a prospectus for share dealers to examine. A prospectus is a document which sets out the fundamental details of the company - effectively an advert for their securities from which traders will make their initial share purchase. Prospectuses must meet certain disclosure requirements and are of a standard form to ensure traders can compare like for like when choosing a company to invest in. Prospectuses provide key details investors need to know about the financial health and performance of the company before investing, and effectively set out the foundation terms against which the shares are issued. Prospectuses can be inspected by public record at any time.

A company has a limited amount of capital available for sale to the general public. This is representative of the capital of the company, and the total capital value of the shares at its disposal. While a company has an authorized capital as a ceiling, it often issues its capital in batches to reserve the ability to raise money at a future date. A company's available capital is the share capital that has been authorized but not yet issued, and reflects the amount of capital that the company can raise, should it need to, by a new share issue.

A company's total capital is the sum of its authorized capital, including both available capital and issued capital. The total capital represents the total value of the company, and the total amount of money it can raise in investment without diluting the interests of existing shareholders. It is possible to increase total share capital only by special resolution of a majority of shareholders, thus in order for companies to extend their available capital and increase the amount of money they can raise from the markets, the shareholders must overwhelmingly support the idea, which is in the first instance contrary to their direct financial interest.

Trading

Leverage is a form of short-term credit extended to traders in order to enable them to invest more aggressively in the markets. Leverage is most commonly associated with derivatives trading, but some brokers are prepared to extend credit to some trading clients. Leverage has the effect of inflating transaction sizes without tying up any more of the trader's capital, effective increasing both the returns and risk potential of share investment. When markets move 1%, the effect on the capital growth of a leveraged investment is much greater, because the position profits from the 1% rise on an inflated transaction size. As a result, some traders use leverage to maximize the returns from the positions they trade, despite the financing costs associated with funding leveraged positions.

Trading shares through leveraged finance is becoming increasingly popular, and even those that don't have access to broker leverage are switching to derivatives and alternative to direct share investment.

The main advantage of trading shares through leverage is that transactions can be inflated in order to deliver greater returns over a shorter period of time. When traders invest in positions that are highly leveraged, they are effectively hitting the accelerator by accentuating every movement of the market. This makes it possible to earn a far greater return on investment over a shorter period of time, thanks to the leveraged portion. However, leveraged trading is inherently risky, and there are pitfalls which can cause complications for traders relying on leverage as part of their trading strategy.

Day trading is trading over the period of no more than a day, and still represents a particularly short term trading strategy in the context of share trading. Day traders look for investment opportunities over the course of a day, and as a result end up trading on emerging trends or market announcements. Day trading is designed to produce a smaller daily yield which compounds into something much larger, and aims to eliminate much of the depth of research and analysis required in identifying longer-term positions. One of the main difficulties with day trading is identifying a sufficient number of opportunities to deliver your daily returns expectations, and this can often lead to high levels of engagement and discipline required from the trader.

How do day traders make a profit?

Day traders try to make a profit by identifying share trading opportunities that are likely to yield a return over the period of the trading day. As a result of the limited time frames, the chances of a home run trade are minimal, with most day traders instead settling for a modest yield from their individual trades which are aggregated across a larger number of individual transactions. Day traders need to be on the constant lookout for opportunities in markets that are set to move on the day, and they need the discipline to cut out early from positions that don't work out to avoid damaging their capital. At the same time, day trading can incur higher costs than regular trading, which hamper and handicap trading performance and yield on capital.

Is day trading expensive?

Day trading can be expensive, but traders can keep it under control. With every trade that is opened, a commission payment is attached and paid to the broker. These can add up to be a considerable expense across a number of transactions, and as a day trader, you will tend to engage in more frequent transactions than other investors. This can make day trading expensive, and can serve as a significant dampener on trading profits. In order to keep a handle on expenses, it's important for day traders to be selective in the transactions they enter, and take a more calculated approach to ensure they are making the best investment choices. Shrewd day trading that delivers a greater yield can reduce the number of transactions required to meet earnings targets.

Is day trading easier than regular trading?

Day trading is often seen as the perfect route of entry for beginners to the share trading markets, providing the instant gratification of daily trading profits and the perceived comfort of knowing that damage is limited to the present trading day. While day trading is often seen as less risky and less intellectually demanding, it nevertheless requires more hardwork and more active management than other trading strategies with a more long-term outlook. In order to make a success of day trading, you need to execute far more trades than those with more traditional strategies, and this means that both the additional research and the extra costs involved should be factored in to deciding whether day trading is still a preferable strategy.

Swing trading aims to tap into the natural cyclical behaviour of markets by identifying shares that are at a turning point price wise. Swing trades back the reversal in markets at a price high, in the assumption that as prices correct and the market gains vitality from a low point, traders can benefit from getting on the curve early. Swing trading can be a particularly effective strategy, and is comparatively easier to research than other strategies and trading signals. The major benefit of a swing trading strategy is that they can tap into the momentum of market corrections and price movements, making successful investment decisions pay with more generous returns.

Momentum trading is a strategy that sees traders following current affairs and economic triggers to identify trading opportunities. Having researched correlations between different economic and market outcomes and trading performance, trading on momentum relies on trading in the immediate run up to and aftermath of relevant news announcements, and some traders rely exclusively on the financial press to provide their trading signals. Momentum trading backs trends that emerge as a result of news announcements or external outcomes which can have a bearing on the market, and as a strategy, anticipating moves in momentum can be particularly lucrative.

Markets tend to trade within loose limits at which shares are either too expensive or too cheap to be sustainable. Traders engaging in technical analysis are often looking for support and resistance price levels, which outline the floor and ceiling prices against which the share has tended to trade. Using support and resistance strategies, traders look to cash in on reversals near the point of support and resistance, and can be used for identifying often lucrative break-outs where markets are trending beyond previous high levels. Support and resistance as a basis for trading can provide a roughly reliable guide to where a share price might be headed, depending on the broader price trend.

Share price trends are easily visible through technical analysis charting tools, which plot historic trading data on a graph to make it more visible and easier to interpret. Charts highlight trends in an instant because line graphs visually demonstrate upwards and downwards trends depending on the direction of the price line. When identifying trends, it's important to remember that the daily trend may be very different from the monthly trend, which may be very different again from the annual price trend. Depending on the projected duration of your trade, you should take care to examine prices across a broadly similar time period in order to best establish the wider trend in market and price movement.

Trading shares over the short term is beneficial from the point of view of market risk. The longer capital is exposed to the market in any form of investment, the greater the chances are that the capital will yield a loss. Statistically, the chances of losing rise dramatically with time, meaning the marginal risks of holding shares for an extra day is considerable. When positions are traded over shorter time frames, this has the effect of reducing market risk, because positions are only exposed for short periods of time. In normal trading conditions, markets can't and don't tend to move far over a day or two, and as a result, traders that have a short-term trading outlook are better placed to nip losses in the bud before they take hold.

While short term investment strategies are seen as presenting a lower market risk profile, they are more expensive than longer term strategies and tend to deliver lower possible yields. An investment that casts an eye to the long term can yield significant capital growth, particularly if a position is allowed a period of six months or a year or more. The extent of movement markets see in a day is limited, but the scope of movement over time is vast - as is the potential for capitalizing from long-term growth in share prices. Trading over a longer timeframe means less frequent, less active and potentially more profitable trading, although this comes at the expense of a higher risk than more short-term focused strategies.

Shares are often traded as a default instrument, and form a crucial part of investment portfolios amongst individual and institutional investors alike. That said, there are a number of alternative instruments, assets and markets in which traders can invest to generate a yield. Markets like commodities are often regarded as a safehaven for investors when the financial markets are choppy, while bonds and debentures offer alternative yield investment securities to shares that are traded publicly. For some, trading in derivatives and contracts for difference represents the most beneficial alternatives down to the flexibility and leveraged earnings that these instruments can provide. However you structure your portfolio, it is important to be aware of the range and scope of alternative investment instruments and classes.

When financial markets are proving uncertain, commodities have always been the number one fall back option for investors looking to maximize their returns. The commodities markets range from trade in soya to coffee to pork bellies to steel to oil, covering a vast range of raw materials that producers need to sell in bulk and manufacturers need to buy. The inherent value in commodities is obvious, with demand provided from the end users who rely on often scarce raw material stocks to ply their trade. Commodities can be traded on markets in much the same way as shares, except commodities markets tend to be more volatile on the whole, presenting a greater risk but also greater reward profile for investors.

Whereas shares are a direct capital quid pro quo investment, bonds are an altogether different instrument, but no less worthwhile as part of a diversified trading portfolio. Bonds are effectively like capital loans, providing a guaranteed yield from the issuer on a guaranteed maturity date. The only risk of bonds not being repaid lies in the risk of business failure, and interest/yield rates are variable according to the financial health of the organization issuing the bonds. Bonds can be issued by both companies and governments as a means of raising finance without selling equity, and as such are a vital tool for organisations looking to fund expansion without selling the farm in the process.

Derivatives are an increasingly popular form of trading for investors as an alternative to shares. In many cases, derivatives are traded on the same companies and markets as shares, but the key difference is that the derivatives themselves are being traded. Derivatives give rights over shares typically, in addition to a host of other instruments, and have a value in their own right - the value of the right to interact with a share on set terms. This often allows traders to gain leveraged exposure to the market, because of the gearing effect of these secondary instruments. This can result in more profitable, albeit much more risky, trading.

How do derivatives work?

Derivatives are instruments which create rights in rights, or rights in underlying assets other than the right of immediate ownership. Generally, derivatives are obligations that enable or compel traders to trade at a certain level at a certain time, and as a result they are instruments which have their own inherent value. Derivatives tend to have a gearing effect in that for a lower price, traders can access a greater proportion of the underlying asset indirectly, thus they tend to be inherently leveraged by design. This, in addition to broker financing which is common in trading derivatives, derivatives markets can deliver much more significant returns than cash markets over much shorter periods of time.

The risks of trading shares are, in a nutshell, that you will lose your entire capital. Share trading can be lucrative and a broadly safe way to generate a return on your capital, but it can also be highly risky if you don't know what you're doing. There are risks inherent in trading in companies and on markets, and even doing business in a global economy poses threats beyond doing nothing. The trick is to learn how to analyse the risks of trading on a per transaction basis, so that you can make sure you're trading with the right risk appetite for your portfolio.

How is risk calculated?

Risk is calculated by examining both the likelihood of damage occurring and the extent of the potential liability involved. A trade that is more likely to fail than another is by definition more risky for the trader, whereas a trade with a large capital investment will be more of a considerable risk than a small sized trade. Calculating risks requires a solid understanding of the probability of accuracy of your research, and consequently traders who want to be better a judging risks and making good trading decisions in the first place should ensure they are expertly knowledgeable about the markets and companies they wish to trade.

How can risk be minimized when trading shares?

Risks can be minimized in a number of different ways. Firstly, having a diversified portfolio means that the risks are spread across a number of individual share transactions, increasing the likelihood of adequate capital protection. The more positions you have open for your money, the less likely it is that they're all going to fail, and arguably the more likely it is that you will profit on your deployed capital. Another way in which risks can be minimized in individual trades is through the use of stop loss orders, which set a guaranteed exit threshold at which shares traders can sell their positions. Stop loss orders provide valuable protection, particularly when used in rising markets to bank profits before a transaction has fully run its course.

What different types of risk are there?

There are a number of risks facing any trader, or anyone who exposes their capital to the financial markets. There's market risk - the risk that the market may collapse during the period of holding your positions. There's inflation risk - the risk that inflation may erode earnings through trading the markets. There's credit risk, the risk that companies will default or become insolvent, not to mention political risk surrounding doing business in any worldwide economy. These different types of risk must always be considered by traders in deciding how to invest, and should be appropriately weighted to give an approximation of whether a particular investment is too risky.

Short selling is the process of reversing regular market transactions in order to give traders the benefit of profiting from asset price decline. Generally speaking, anything that is sold has to firstly be purchased by the trader. After all, how can it be possible to sell something you don't own? Short selling reverses the process, and allows traders to sell their positions now with a view to buying back later - hopefully at a lower price. Short selling is more easily achieved through trading in derivatives, which give traders the choice of trading in either direction, and it can be a good measure of flexibility in building a diversified, profitable portfolio.

Dividend trading is a trading strategy that relies on dividend yields rather than capital growth. Most traders who engage in the share markets do so with a view to achieving capital growth in their position - in other words, price speculation. Dividend trading is in many respects the opposite approach, with traders choosing shares not on the basis of their potential capital growth but on the basis of the dividends they declare. With some shares being more generous than others in terms of the dividends they declare, dividend traders tend to pick those that are the highest yielding to reap the rewards of dividend payments over the longer term.

Starting to trade shares is fairly straightforward for those with capital to invest. The first step is to choose a broker and a brokerage platform, and to become familiar with how technically trading works. A test trading period is also advisable, in order to give traders the best chance to learn how the markets function before investing their money for real. Beyond that, traders simply need to start researching the positions and strategies in which they intend to invest before depositing their capital, and taking that all important first step towards playing the markets.

Which broker should I choose?

Choosing a broker is a matter of personal preference to a large extent, and there is no right or wrong answer as to who best meets the needs of traders. Luckily, there are countless online and bricks and mortar brokers for you to choose from, providing a highly competitive environment in which investors can find a great deal. Choosing the right broker is an important step, and it pays to get it right. As a result, traders are recommended to consult comparisons and reviews of brokers before finalizing their decision as to which broker best suits their needs.

Penny stocks are shares in smaller companies that are often less heavily traded and tend to be less expensive - under £5 a share, for example. Penny stocks are traded in environments that are more volatile and less liquid than the larger traded stocks, and this provides opportunities for more capital growth and more volatile trading. Penny stocks are not specifically defined as such, and simply refer to low priced stocks which some traders choose as the focus of their investment strategy as a means of lowering the risk profile and delivering higher rates of return in capital.

What are the advantages of trading in penny stocks?

Trading penny stocks as a strategy can be a lower risk way to access the markets. When traders buy in to FTSE100 companies, it tends to be the case that these companies are already established and are priced fairly statically over time. Penny stocks are often smaller companies that are growing, and the markets for their securities are less liquid and less heavily populated. This makes it possible to see lower risk, higher volatility trading, which can often outstrip growth amongst larger asset prices. And, because each share is lowly priced, traders can engage in markets for penny stocks without exposing too much of their capital to these smaller, quirkier markets.