1. You buy a security
2. This security follows a currency
3. Soon when that currency goes up
4. The value of your security will go up
5. This all equals derivatives
Let’s break this down
You are searching for alternative investments and you think about getting into this security that follows the price of a currency, so when the currency value goes up, the security itself will go up as well. As well as when the currency value goes down then your security will go down as well. This all equals a derivative
A derivative is a security that you can buy as an investor, this security's value is based on and derived from other assets, such as stocks, bonds, currencies and much more. Right now, for example, there are derivatives that are based on Bitcoin.
Why Do You Care?
• Derivatives can be used for Hedging, which essentially helps you protect your investments that are in foreign currency. For example, you would buy a foreign currency derivative to protect your downside if the currency dropped.
• Speculation is another very common use case, as people buy derivatives of gold and most recently Bitcoins.
• Most common use cases are Future Contracts, where you agree to the sale of a company at a set price.
The Good, The Bad, The Ugly
• This is a great way to get into speculative asset classes without taking on all the risk (The Good)
• These are often confusing and there are so many different asset classes you can invest in, which makes it hard to understand what is a good investment and what is not. (The Bad)
• You cannot control what the other assets do, meaning there is a lot of volatility (The Ugly)