Financial markets: What they are, how they work, and how to invest in them

At a glance:

  •  Financial markets are organised or decentralised systems in which instruments such as shares, bonds, investment funds, ETFs, currencies, derivatives, commodities, and cryptocurrencies are issued and traded. They provide access to a variety of different regions, sectors and asset classes, thereby helping to diversify one’s portfolio.

  •  However, investing in financial markets carries risks, such as market volatility, capital loss, currency fluctuations, liquidity risk, and behavioural risks.

  •  Banco Carregosa gives you access to global markets through its GoBulling and Markets Service platforms, which are supported by specialist teams.

A sudden increase in geopolitical risk can cause movements to occur almost simultaneously across different markets. Fears of supply disruptions may cause commodities to rise; economic uncertainty may cause shares to react; demand for assets considered more defensive may cause bonds to benefit, or conversely, they may come under pressure from inflation expectations; and currencies may appreciate or depreciate depending on each economy’s exposure. The effects are not consistent and depend on the nature of the shock, the initial conditions, and the expectations of investors.

This example shows that financial markets do not operate in isolation; they are part of an interconnected system that responds to – and sometimes amplifies – economic, political and social events. From this perspective, it is important to understand what financial markets are, how they are organized, and what role they play.

What are financial markets?

Financial markets are structures, whether organised or decentralised, through which financial instruments such as shares, bonds and investment funds are issued and traded, and through which capital and risk are transferred between different economic agents.

In practice, they connect companies and governments seeking finance with retail and institutional investors looking to invest their capital. They also play a part in setting prices and providing liquidity, as well as hedging and transferring risks.

One of their key characteristics is their price-formation mechanism. Markets continuously reflect the expectations of their participants. For example, the price of a share not only reflects a company’s current situation, but also takes into account expectations regarding future growth, financial results, macroeconomic conditions and risk perception.

Main markets and financial instruments

There are different markets, asset classes, instruments and investment vehicles, each of which has its own distinct functions, level of complexity and risk. Understanding these differences helps investors to better understand their actual exposure.

How to choose which financial instruments to invest in

Primary market vs. secondary market: what are the differences?

In order to better understand how financial markets work, it is important to distinguish between the two key stages in an asset’s life: its initial issue and its subsequent trading amongst investors.

The primary market is where financial assets are first issued and sold directly to investors. Transactions such as initial public offerings (IPO) take place in this context, enabling companies to raise capital for growth.

The secondary market, on the other hand, is where these same assets are traded among investors. The majority of day-to-day transactions take place here, which is crucial for market liquidity and continuous price formation.

Investing and trading: what is the difference?

Although investing and trading often utilise the same markets, they are primarily distinguished by their time horizon, the frequency of decisions made, the level of portfolio turnover, and the type of risk taken. There is no absolute separation between analytical methodologies such as fundamental, technical, quantitative and macroeconomic analysis, and they may overlap.

The advantages of investing in the financial markets

Investing in the financial markets can be highly beneficial, particularly for those looking to grow their wealth in a structured way over time.

Access to different risk profiles and returns

Financial markets offer access to a variety of assets with different risk and return profiles. Although prolonged periods of loss have occurred, broadly diversified share indices have historically appreciated over the long term. However, there is no guarantee that this performance will be repeated.

Diversification across asset classes, sectors, and geographies

Combining assets, sectors and geographies with different behaviour patterns can reduce specific risks and stabilise portfolio volatility. However, diversification does not eliminate market risk, nor does it guarantee protection in all scenarios, as various asset classes, such as shares and bonds, can lose value simultaneously.

Efficiency and transparency

Financial markets provide a significant amount of information, including company results, economic data, and trading prices. While it does not eliminate uncertainty or make asset performance predictable, this transparency enables more informed decisions to be made and contributes to price formation.

Global access and greater cost efficiency

You can now access international markets via funds and ETFs. While many diversified ETFs have relatively low management fees, you should still assess the total cost, spread, liquidity, replication structure, currency and trading costs.

Risks of investing in financial markets

Although there are advantages to investing in financial markets, it involves various types of risk that must be understood and assessed collectively before being incorporated into the strategy.

Volatility and market behaviour

In the short term, asset prices can fluctuate significantly in response to news, economic data, or unexpected events. However, volatility is just one aspect of risk, and it should not be confused with the overall risk of an investment.

Risk of permanent capital loss

In addition to temporary fluctuations, there is a risk of permanent capital loss, particularly with regard to specific or highly concentrated assets. A more in-depth analysis can identify structural problems, defaults, or lasting deterioration in fundamentals, all of which may affect value permanently.

Concentration risk

A portfolio may appear to be diversified, but it could still be exposed to the same sectors or companies through different instruments. This concentration increases risk, though this may not be immediately apparent, meaning a more detailed analysis of the composition of the investments is required.

Impact of macroeconomic factors

Several asset classes can be affected simultaneously by factors such as interest rates, inflation, economic growth, and monetary policy decisions. The impact of these factors on each instrument depends on its duration, credit quality, currency, sector, and sensitivity.

Behavioural risk

Decisions based on fear, euphoria or overconfidence have the potential to compromise results. While having pre-defined rules and a coherent strategy can help reduce the likelihood of impulsive decisions being made, they cannot eliminate the risk of error entirely.

Exchange risk

The final return in euros when acquiring assets denominated in foreign currencies also depends on exchange rate fluctuations. An increase in the value of the euro may reduce the gains made on the asset, whereas a decrease in its value may increase them. Where available, currency hedging also incurs costs and has limitations.

Liquidity, credit and counterparty risk

It may be difficult to sell some instruments quickly without significantly impacting the price. There is also a risk that the issuer or counterparty may default on their obligations, including failing to make interest payments, repay principal or settle contracts.

Interest rate, inflation, and reinvestment risk

Changes in interest rates can affect the value of bonds and other assets. Inflation can reduce the purchasing power of returns, while reinvestment risk arises when received cash flows can only be reinvested at less favourable rates.

Leverage, operational and regulatory risk

Leverage can amplify both gains and losses, potentially resulting in losses exceeding the initial investment in certain instruments. Investment outcomes can also be affected by technical failures, operational errors, regulatory changes or custody issues.

Volatility and total risk are not synonymous

Even if an asset exhibits minimal price fluctuations, there may still be a risk of default, a lack of liquidity, a permanent loss of capital, erosion by inflation, or unsuitability for the investor’s financial needs. It is therefore essential to assess risk from multiple perspectives.

How to invest in financial markets

Investing consistently requires a structured approach. This begins with an assessment of the investor’s financial situation, followed by the setting of objectives, the assessment of risk, the building of a portfolio, the selection of instruments, and the regular monitoring of progress.

1. Assess your financial situation and liquidity needs

Before investing, it is important to assess your overall financial situation. This means having an emergency fund, anticipating your future cash flow needs, having a stable income, and keeping your level of debt under control.

Without this framework, investors may have to sell assets at unfavourable times, which could compromise their strategy and turn temporary volatility into realised losses.

2. Set objectives and assess your risk profile

Before creating a portfolio, it is important to set specific objectives, target amounts, the time horizon, and the ability to make contributions. Projections should be based on prudent scenarios, bearing in mind that returns cannot be controlled or guaranteed.

The assessment should distinguish between emotional risk tolerance and financial capacity to withstand losses, as well as the level of risk required to achieve the objective. To evaluate results in net and real terms, inflation, costs and taxation must also be taken into account.

3. Build a portfolio with clearly defined roles

An effective portfolio is not the result of selecting assets in isolation, but of how they complement one another. In line with the time horizon, liquidity needs, and risk appetite, each component must fulfil a role within the strategy.

Global equities can contribute to long-term growth, while bonds, funds and other less volatile instruments can stabilise a portfolio. However, the term "conservative” is not enough on its own. The composition, duration, credit quality, currency, liquidity, concentration and costs must all be analysed.

4. Choose the markets and instruments

Once the objectives, risk profile and portfolio structure have been defined, the next step is to select the most suitable markets and instruments.

When making this selection, you should consider potential returns, risks, the complexity of the investment, and how much time you have available to monitor the portfolio. Direct investment in shares gives you control over the securities held, but it requires greater analytical ability and tends to increase specific risk. Although they do not eliminate market risk, diversified investment funds and ETFs can help mitigate it.

One possible approach is the core-satellite structure, in which the majority of the portfolio is diversified, and the smaller, more specific positions complement it. However, this is not a one-size-fits-all solution and must be tailored to the investor’s profile.

5. Choose a suitable platform and financial intermediary

It is crucial to choose a financial intermediary that is consistent with the degree of autonomy required, the complexity of the instruments and the level of support needed.

In addition to costs, it is important to consider the following factors:

  •  The firm’s regulatory status and the protection and segregation of client assets;

  •  The quality of the platform, digital security, and order execution;

  •  Full details of commissions, spreads, exchange rates, custody, and financing;

  •  Market access, customer support, tax information, and the handling of corporate events.

GoBulling, offered by Banco Carregosa, provides access to a variety of international markets and analytical tools. However, whether or not the platform is suitable depends on each investor’s profile, knowledge, experience and needs.

Those who prioritise autonomy may value functionality and cost-effectiveness, while those seeking guidance may benefit from solutions that offer specialised support tailored to their investor profile.

6. Assess the costs and tax implications

In the long term, costs have a direct impact on net returns. When making your calculations, you should take into account trading and custody fees, as well as the internal product costs (including funds and ETFs), spreads, currency conversion costs, financing costs, taxes, and any transfer or closing fees.

Small differences can have a significant effect over time through compounding. Therefore, comparisons should be based on the total cost rather than just the buy and sell fees.

7. Adopt a consistent investment strategy

One of the key decisions is ‘how’ and ‘what’ to invest in. Taking a regular and disciplined approach can minimise the need for ad hoc decisions and attempts to predict market movements.

Staggering investments can reduce the risk associated with entry timing and encourage discipline. However, it does not guarantee lower average prices or better results than immediate investment, especially when markets are trending upwards. It may, however, be more advantageous in volatile markets.

8. Diversify and make regular adjustments

Over time, it is important to monitor diversification, as uneven asset appreciation can alter the initially defined level of risk.

Following a period of strong appreciation, a portfolio may become overly exposed to a specific asset class. Periodic rebalancing, either according to a fixed schedule or based on deviation limits, enables the intended allocation, which is aligned with the investor profile, to be restored, taking into account costs and tax implications.

9. Distinguish between volatility and structural changes

It is not always possible to tell the difference between a temporary correction driven by volatility and a structural change at the time. Decisions must therefore be based on pre-defined criteria, up-to-date analysis and the asset’s suitability for the strategy.

While this approach helps avoid hasty decisions, it does not eliminate the need to review a position when there is a significant change in the fundamentals, risk, or the asset’s role in the portfolio.

10. Maintain discipline and decision-making criteria

Maintaining clear criteria, reviewing assumptions and avoiding purely reactive decisions is generally a more robust approach than repeatedly altering the portfolio in response to short-term movements.

Financial markets: investing with the support of Banco Carregosa

Founded in 1833, Banco Carregosa is an independent financial institution based in Porto, boasting nearly two centuries of experience. Its development has been linked to wealth management, innovation in financial markets, and supporting clients with complex needs. This long-standing experience informs an approach that is based on continuity, stability, and a long-term vision.

For the second consecutive year, Banco Carregosa has been named Best Pure-Play/Boutique Private Bank in Portugal at the Euromoney Private Banking Awards 2026. This accolade recognises the Bank’s specialised position in wealth management and private banking. The awarding body is solely responsible for the award.

With over 190 years of experience, Banco Carregosa manages assets under supervision totalling more than 5 billion euros and employs over 150 specialists, thereby reinforcing its position in supporting investors, families, and complex wealth structures.

Investing in financial markets: FAQs

We’ve answered some of the most frequently asked questions about financial markets below.

Are the financial markets suitable for all investors?

Not necessarily. Whether or not an investment is suitable depends on the objectives, financial situation, knowledge, experience, risk tolerance, and time horizon of each investor.

What is the minimum amount needed to start investing?

As the minimum amount depends on the investment instrument and the platform, there is no universal figure. It is more important to maintain an emergency fund, manage debt, and ensure that the investment is compatible with your liquidity needs than to have initial capital.

Can you lose money in the financial markets?

Yes. Investing in financial instruments carries risks, including the possibility of losing some or all of the capital invested. Past performance is no guarantee of future results.

How can I minimise risk when investing?

Although risk cannot be eliminated, it can be managed by diversifying your investments, aligning them with your time horizon, controlling position size, limiting leverage, maintaining liquidity, assessing costs, and periodically reviewing your portfolio. You may be able to withstand market fluctuations if you have a longer time horizon, but this will not stop you from suffering permanent losses.

What is the difference between investing in shares and bonds?

When you buy shares in a company, you acquire a stake in its capital, which makes you vulnerable to changes in its value. You may receive dividends if they are declared. When you buy bonds, you are essentially lending money to a government or company in exchange for interest payments and the scheduled repayment of the principal amount, both of which depend on the issuer’s ability to fulfil its obligations. Depending on interest rates, credit risk and liquidity, the price of the bond may fluctuate before maturity.

Legal Disclaimer: This article is intended for informational and educational purposes only. It does not constitute an investment recommendation, personalised financial advice, an offer, an invitation or proposal to buy or sell financial instruments. Investing in financial instruments carries risks, including the possibility of losing some or all of your invested capital. Past performance does not guarantee future returns. Before making any investment decisions, you should assess whether the instrument is suitable for your risk profile, objectives, financial situation, knowledge and experience. You may also wish to seek specialist advice.