Financial Instruments are intangible assets, which are expected to provide future benefits in the form of a claim to future cash. It is a tradable asset representing a legal agreement or a contractual right to evidence monetary value / ownership interest of an entity.
Financial Instruments can be classified as cash instruments and derivative instruments.
Financial Instruments are typically traded in financial markets where price of a security is arrived at based on market forces.
Selection Criteria of Financial Instruments
Let’s consider the factors that should be considered in selecting financial instruments:-
- Liquidity: This refers to the ease of buying and selling a financial instrument at any given time. Instruments with high levels of liquidity tend to be easy to trade as one can enter and exit a position with ease.
- Volatility: Volatility refers to the ability of financial security to rise and fall sharply. That said volatility is a two-edged sword that can be a blessing and a curse at the same time. High volatility tends to work to the advantage of traders who know what they are doing as it allows them to generate profits multiple times. However, a small mistake in times of high volatility, losses tend to accrue much faster.
- Low Transactions costs: A financial instrument with low transaction costs is ideal as it allows one to generate optimum returns on any given trade. Brokers charge different trading fees for different financial instruments.
- Availability of Information: Free flow of information is necessary if one is to have a profitable trading career trading given security. News affects prices from time to time this one should only trade an instrument whose news or information is readily available.
