A security is any financial instrument with a fungible value that investors can trade. Common securities include stocks, bonds, index and mutual funds as well as options and other derivatives that derive their value from other assets. Most securities trade on financial exchanges, and all play a role in aiming to build wealth for individuals, companies, and other investors.
What are investment securities and how do they work? Here’s a glimpse inside the world of securities in trading.
What is a Security?
A security is a tradable investment vehicle that traders can buy and sell on financial exchanges or other platforms. In general, investors earn money by buying securities at a low price and selling them at a higher one.
Securities have some monetary value, buyers and sellers determine when trading them. Securities vary in nature – stocks, for example, represent ownership in a company, while bonds are essentially loan vehicles where borrowers pay lenders interest for their loan money.
Here are some common security categories
This group includes stocks and stock funds. Typically traded on exchanges, the price of equity securities rise or fall depending on the economy, the performance of the underlying company or that offers the stock (or companies in the fund), and the sector that company or fund operates. Individual stocks may also pay dividends to investors who own them.
This group includes bonds and other fixed-income vehicles where lenders borrow money from investors and pay an interest rate (i.e., the price for borrowing) on the investment principal. Bond issuers may include states, local and municipal governments, companies, and banks and other financial institutions. Typically, debt securities pay investors a specific interest rate paid usually twice per year until a maturity date, when the bond expires.
Some common debt securities include:
• Treasury bills. Issued by the U.S. government, T-Bills are considered among the safest securities.
• Corporate bonds. These are bonds issued by companies to raise money without going to the equity markets.
• Bond funds. These allow investors to get exposure to the bond market without buying individual bonds.
This group of securities includes higher-risk investments like options trading and futures which offer investors a higher rate of return but at a higher risk investment level.
Derivatives are based on underlying assets, and it’s the performance of those assets that drive derivative security investment returns. For example, an investor can buy a call option based on 100 shares of ABC stock, at a specific price and at a specific time before the option contract expires. If ABC stock declines during that contract period, the call option buyer has the right to buy the stock at a reduced rate, thus locking in gains when the stock price rises again.
Derivatives allow investors to place higher-risk bets on stocks, bonds, and commodities like oil or gold, and currencies. Typically, institutional investors, such as pension funds or hedge funds, are more active in the derivative market than individual investors.
Recommended: A Guide To Derivatives Trading
A hybrid security combines two or more distinct investment securities into one security. For example, a convertible bond is a debt security, due to its fixed income component, but also has characteristics of a stock, since it’s convertible.
Hybrid securities sometimes act like debt securities, as when they provide investors with a floating or fixed rate of return, as bonds normally do. Hybrid securities, however, may also pay dividends like stocks and offer unique tax advantages of both stocks and bonds.
How Security Trading Works
Securities often trade in open financial exchanges where investors can buy or sell securities with the goal of making a financial profit.
Stocks, for example, are listed on global stock exchanges and investors can purchase them during market trading hours. Exchanges are highly regulated and expected to comply with strict fair-trading mandates. For example, U.S.-based stock exchanges like the New York Stock Exchange or Nasdaq must adhere to the rules and regulations laid out by Congress and enforced by the U.S. Securities and Exchange Commission (SEC).
Each country has their own rules and regulations for fair and compliant securities trading, including oversight of stocks, bonds, derivatives, and other investment vehicles. Debt instruments, like bonds, usually trade on secondary markets while stocks and derivatives are traded on stock exchanges.
There are many ways for investors to engage in security trading. A few of the most common ones include:
Once an investor opens a brokerage account with a credentialed investment firm, they can start trading securities.
All a stock or bond investor has to do is fill out the required forms and deposit money to fund their investments. Investors looking to invest in higher-risk derivatives like options, futures, or currencies may have to fill out additional documentation proving their credentials as educated, experienced investors. They may also have to make larger cash deposits, as trading in derivatives is more complex and has more potential for risk.
Some investors with brokerage accounts can engage in margin trading, meaning that they trade securities using money borrowed from the broker.
By opening a retirement account, through work or a bank or brokerage account, investors can invest in a range of securities, including stocks, mutual and index funds, bonds and bond funds, and annuities.
The type of securities you have access to will depend on the type of retirement account that you have. Workplace plans typically have fewer investment choices (but higher limits for tax-advantaged contributions) than Individual Retirement Accounts.
There are many different types of securities that investors may purchase as part of their portfolio. Choosing which securities to invest in will depend on several factors, including your financial goals, current financial picture, and risk tolerance.
A great way to start building a portfolio of securities is by opening a brokerage account on the SoFi Invest® investment platform. Securities on the platform include stocks, exchange-traded funds, and cryptocurrencies.
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