One of the key decisions that must be made by a trader who is working in the area of derivatives combines the use of mathematics. There are many people who are not very well familiar with mathematics or statistics and always trade by heart. Of course, sometimes the level of mathematical sophistication might be too complicated and many practitioners will not understand these subjects.
If we measure derivatives in terms of underlying assets then this market is much greater than a stock market. Derivates are used for speculation, hedging or arbitrage and have the value of the assets underlying outstanding derivatives transactions several times higher than the world gross domestic product. Derivatives are important when transferring a wide range of risks. Derivates values depend on the values of other underlying variables. Frequently the variables underlying derivatives reflect the prices of traded assets. For example, a stock option represents derivates whose value depends on the price of a stock. Though, derivatives can be dependent on almost any variable, from the price of grains to the damage caused by flooding in a certain country.
Since 1988 there have been many changes in derivatives markets. Nowadays we can observe operative trading in electricity derivatives, credit derivatives, insurance derivatives or weather derivatives. There have been rise of many new types of derivatives, such as interest rates, equity or foreign exchange products. However, trading in derivates markets come under great deal of risk. Derivatives had a great role in the credit crisis that started in 2007. Securitization procedure in the USA was used to create derivatives products from portfolios of risky mortgages. The majority of these products became worthless after house prices had declined drastically. Subsequently investors and financial institutions all over the world faced serious losses and this caused huge recession the world had incurred over the last decades.
For a long period of time derivates exchanges have used the open outcry system, which traditionally immerse a physical meeting on the floor of the exchange, shouting, and using complicated set of hand signals in order to determine the most profitable trades. However nowadays open outcry system is being progressively replaced by an electronic trading. Electronic trading facilitates a trading process by matching buyers and sellers in the market. Definitely, as time passes the open outcry system becomes less frequently used.
At present we can realize the rise of a new type trading known as algorithmic trading (sometimes noted as robo trading, high-frequency trading, automated trading or black box trading). Often algorithmic trading initiates trades without a human meddling by the use of predetermined computer programs. In most cases humans just watch the trading processes and interfere in the process if something drastic occurs.