Financial instrument definition – What is it? – Explanation

What are financial instruments? – Definition

The Financial market seems to be a book with seven seals for many people. No matter whether you plunge into this thicket yourself or consult an advisor – you have certainly encountered various financial instruments more than once. Although this term is often used in an inflationary manner, its definition is not always clear. Of course, it is essential to know exactly what you are investing in. This is just one of the reasons why we want to take a closer look at the topic of “financial instruments”. Hopefully, this article will shed some light on the subject.

Financial instruments are investments that can be traded.

Financial instruments – a simple definition

Basically, a financial instrument can be seen as an asset that can be traded between two parties – personally or anonymously. The ability to buy or resell such an instrument is essential to the definition of this term. In other words, a financial instrument can also be seen as a financial contract. While the buyer receives an asset, the seller incurs a financial liability.

Financial instruments can take different forms. Depending on this, they can be classified into different Asset classesso-called assets. However, there is also another way of distinguishing financial instruments. This is explained in the following section.

Complex and non-complex financial instruments

Trading in complex financial instruments requires a lot from the respective trader. In addition to a solid technical knowledge, he also needs somewhat stronger nerves for this type of trading. Under the category “Complex financial instruments” are for example derivatives, CFDs or futures. Often, complex financial instruments are associated with higher profit expectations. At the same time, however, a high loss is also possible under certain circumstances. The trader should therefore really be familiar with the matter.

With non-complex financial instruments, on the other hand, less knowledge is required, although you should of course be aware of what exactly you are getting into. Investing blindly in something unknown is never a good idea. This includes, for example, stocks or bonds. Participation in funds also belongs to this category. The investor can therefore decide here whether to trade in these financial instruments himself or to leave the responsibility to a fund manager and “only” provide the money, so to speak.

Less relevant for private investors, but still very interesting, is the accounting of these instruments for a company. In particular, the correct reporting of derivative financial instruments is very complex.

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Where can you trade financial instruments?

In order to delve deeper into the financial market, a securities account is necessary. This can be done either with an online broker or at your regular bank. The first version usually attracts with lower fees, but often seems “uncontrollable, especially for beginners.” Depending on what financial instruments you want to buy, however, the right choice of provider can be crucial. If you “only” want to run a “buy and hold” strategy with stocks or ETFs, you can tend to tolerate higher fees, as they get lost in the “noise” with an investment horizon of 20 years.” Experienced traders who want to specialize in CFDs, derivatives or futures, on the other hand, should tend to look for lower costs. Mostly their frequency in trading much higher, which means they place more orders overall – which of course has a negative impact on returns when fees are high. Those who do not yet dare to enter the financial market on their own can, of course, also visit their trusted financial advisor and have the various options explained to them.

Conclusion: Because you know what you are doing

Whatever financial instrument you finally decide on: You should always know exactly what you are doing. So you should not only understand the instrument itself, but also be able to weigh up the opportunities and risks carefully. While the non-complex financial instruments are more suitable for safety-oriented investors, the complex instruments can be just the right choice for an investor who tolerates some risk. Either way: Make sure you are the master of your finances and never invest in a financial instrument unprepared and naïve. And keep in mind two most important rules: invest only with money you don’t need to live on and try not to lose it if possible. Have fun with it!

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