What is derivative?

Derivative is a contract between two or more people to buy or sell some thing in future date with pre-specified price, whose price is derived from it's underline assets. Underline assets can be stock , commodity , currency etc. Let us look a currency derivative example. 

If you've ever traveled to another country, you usually had to find a currency exchange booth at the airport, and then exchange the money you have in your wallet into the currency of the country you are visiting.

You go up to the counter and notice a screen displaying different exchange rates for different currencies. You find "Japanese yen" and think to yourself, "WOW! My one dollar is worth 100 yen?! And I have ten dollars! I'm going to be rich!!!" (This excitement is quickly killed when you stop by a shop in the airport afterwards to buy a can of soda and, all of a sudden, half your money is gone.)

When you do this, you've essentially participated in the Derivative market! You've exchanged one currency for another. Or in Derivative trading terms, assuming you're an American visiting Japan, you've sold dollars and bought yen.

Before you fly back home, you stop by the currency exchange booth to exchange the yen that you miraculously have left over (Tokyo is expensive!) and notice the exchange rates have changed. It's these changes in the exchanges rates that allow you to make money in the foreign exchange market.

The foreign exchange market, which is usually known as "Derivative" or "FX," is the largest financial market in the world. Compared to the measly $74 billion a day volume of the New York Stock Exchange, the foreign exchange market looks absolutely with its $4 TRILLION a day trade volume. Other transition volume is as follow.

• $1.490 trillion in spot transactions
• $475 billion in outright forwards
• $1.765 trillion in foreign exchange swaps
• $43 billion currency swaps
• $207 billion in options and other products (Best date 2012 July 11)

Let's take a moment to put this into perspective using monsters...

The largest stock market in the world, the New York Stock Exchange (NYSE), trades a volume of about $74 billion each day. If we used a monster to represent NYSE, it would look like this...

You hear about the NYSE in the news every day... on CNBC... on Bloomberg...on BBC... heck, you even probably hear about it at your local gym. "The NYSE is up today, blah, blah". When people talk about the "market", they usually mean the stock market. So the NYSE sounds big, it's loud and likes to make a lot of noise.

But if you actually compare it to the foreign exchange market, it would look like this...

Oooh, the NYSE looks so puny compared to Derivative! It doesn't stand a chance!

Check out the graph of the average daily trading volume for the Derivative market, New York Stock Exchange, Tokyo Stock Exchange, and London Stock Exchange:

The currency market is over 53 times BIGGER! It is HUGE! But hold your horses, there's a catch!

That huge $4 trillion number covers the entire global foreign exchange market, BUT retail traders (that's us) trade the spot market and that's about $1.49 trillion. So you see, the Derivative market is definitely huge, but not as huge as the media would like you to believe.

Do you feel like you already know what the Derivative market is all about? We're just getting started! In the next section we'll reveal WHAT exactly is traded in the Derivative market.

(Source : baby pips.com, and google search)