Forex vs Stocks | What Are The Differences?
Finding success in the stock market can be difficult. Luckily, there's a better way. Stock traders all over the world are switching to forex because of the many advantages of the forex market. With forex, you'll discover 24-hour trading and high turnover volume. Plus, with the forex market, you can turn small movements into big opportunities (for profit or loss).
Regardless of your trading style, the diversification offered by the global currency market is best not ignored. From the major forex pairs, to crosses and exotics, the opportunities are boundless.
What Are The Differences Between Stocks And Forex?
The foreign exchange market (forex for short) and stocks can usually be bought in the same place, but represent two very different securities. Make no mistake, shares and FX trading are two unique endeavours.
Stocks are an equity, representing you owning a piece of a publicly traded company. The value of that stock fluctuates with the value of the company. Forex on the other hand, is a marketplace for the buying and selling of world currencies like the US Dollar or the euro.
Stocks are generally more popular to trade. They have a lower barrier of entry (for the most part) and are generally more intuitive to both passive and active investors. Trading forex has a steeper learning curve than trading stocks, but it's by no means insurmountable. We will take you through the various ways that forex and stocks differ in the following guide.
Forex vs Stock Trading Hours
With the Asian-Pacific, European and American sessions, stock and forex traders are able to conduct business around the clock on a near-24/5 basis. However, while the market may be technically open for business, conditions will vary.
On the forex, off-trading hours exhibit low participation, wide bid/ask spreads and choppy price action. These "off hours" do vary with respect to regional time zones. However, many currency day traders aim to target the regional market open and close to capitalise on significant currency price movements. Although far from an exact science, periods such as the London, New York and Tokyo open/close regularly feature high liquidity.
Equities are much more regimented in this area, with optimal liquidity being relegated to the local stock exchange session. Although after-hours stock trading may be permitted, participation is sporadic and there are added restrictions. So, if you trade blue chips, mid-caps and small-caps, your trading sessions are somewhere in the neighbourhood of eight hours.
The Role Of Leverage
One of the largest differences between stock and forex trading is the role of leverage in each discipline. Although both currency pairs and equities may be leveraged, margin requirements do vary according to broker, municipality and market conditions.
As a general rule, forex leverage far exceeds that found in the stock markets. In fact, the maximum leverage available for many equities products is 2:1. Essentially, this means that a 50% maintenance margin must be held in the trading account to open a new position. Forex leverage is much greater, with industry-leading brokers offering upwards of 30:1 leverage for major pairs. This equates to a minimal 3.3% margin, vastly enhancing capital efficiency and strategic flexibility.
Leverage is the proverbial "double-edged sword." While added leverage boosts the profitability of strong trading opportunities, its availability promotes high risk behaviour in the markets. Without adhering to a structured risk management plan, active traders are likely to face insolvency.
In the financial markets, volatility refers to periodic fluctuations in a security's price. Like leverage, volatility is dual natured ― it magnifies both assumed risks and potential rewards.
As any successful stock or forex trader knows, volatility must be accounted for at all times. On the forex, short-term and long-term exchange rate volatility may spike for many reasons. Among the most common are scheduled economic events, surprise news items and central bank announcements. The periods of time surrounding these happenings are often exceptionally volatile as market participants attempt to price the event in question.
Examples of such key events are central banking activities from the United States Federal Reserve (Fed), Bank of England (BoE) and the Bank of Japan (BoJ). Amid such engagements, currency pairs including the US dollar (USD), British pound sterling (GBP) or Japanese yen (JPY) are highly likely to exhibit heightened price action.
Stock market volatility shares these drivers, but is also impacted by several unique underpinnings. The periods surrounding the daily market open/close and the release of corporate earnings reports are two of the most prominent.
Earnings reports are typically released before or after stock exchange hours. This can lead to an extreme form of volatility: gaps between session opening and closing prices. To illustrate, assume that Apple (AAPL) is slated to release quarterly earnings after the closing bell on a Tuesday. If Apple misses expectations, shares of AAPL stock are likely to open down the next day. Conversely, if earnings are outstanding, AAPL may be in for a bullish gap up on the subsequent opening bell.
Generally, pricing volatility is looked upon by active traders as a good thing. When price is on the move, it is in a state of disequilibrium. Plus, there are more buyers than sellers or sellers than buyers. This furnishes active traders with opportunities to cash in on the chaotic price action.
One way that individuals address volatility is through applying technical analysis. Technical analysis is the study of past and present price action with the goal of projecting future market behaviour. It is a powerful discipline frequently integrated in swing, intraday and day trading strategies.
From a practical standpoint, the stock and forex markets share many influences. Politics, economic cycle and central banking policies impact the valuations of both asset classes. However, stocks are often acutely influenced by local factors while forex currency pairs reflect a much broader sentiment.
It's important to remember that share value is dependent upon the performance of the issuing company. Lagging profitability or an upheaval in leadership are two local issues that can influence a company's stock, but not the larger equities market. No matter if a stock or group of stocks experience a downturn, their respective index or indices is likely to hold its value.
By comparison, a forex currency pair is priced according to a country's economic performance and evolving central banking policies. For instance, the USD is valued according to U.S. economic prowess, global conditions and Fed monetary policy―not sectoral, regional, or local market drivers.
Pragmatically, the valuation of forex pairs is rooted in macro economics and systemic financial influences. On the other hand, stock prices are largely dependent upon sectoral performance and position within their given industry.
The rise of technology in finance has increased the size of the forex and global stock markets exponentially. Retail and institutional traders from around the world are now able to engage the markets via software trading platforms and internet connectivity. The increased volumes have benefited traders in many ways, namely by decreasing traditional barriers-of-entry. Long gone are the days of exchange seats and six-figure deposit minimums―all you need to trade is an internet connection, a bit of risk capital and a brokerage account.
Comparatively, forex trading offers a collection of unique advantages over stock trading. Featuring reduced margins, consistent volatility and extended trading hours, the forex is a viable alternative for nearly every retail trader. Market depth, however, may be the forex's single greatest benefit. Boasting an average daily turnover of US$5 trillion, the forex offers participants maximum liquidity on a near 24/5 basis. For anyone debating whether to trade stocks or currency pairs, the robust market depth and growth potential of the forex is a major consideration.
In comparison, consider the following information:
- The New York Stock Exchange's daily trading volume averaged US$38.5 billion during the first five sessions of May 2017
- The Nasdaq's daily trading volume averaged close to US$85 billion during the first four sessions of that same month
While the forex market's daily trading volume exceeds US$5 trillion, the U.S. dollar is responsible for nearly 88% of total trading volume, additional BIS figures reveal. This brings the greenback's daily trading volume to more than US$4 trillion.
Is Forex Trading Better Than Stocks?
In reality, your best market will depend upon your capitalisation, expertise and financial objectives. That being said, forex trading is superior to stock trading in several ways.
The forex offers participants extended market hours and the ability to trade the Sydney, Tokyo, London and New York sessions without limitation. The extra time vastly expands the number of potential trading opportunities as well as offering diversification flexibility.
Also, you are able to trade your opinions on the world's largest economies via forex majors instead of mixing and matching individual stocks. For instance, assume that you were bullish on the economic potential of the eurozone and projecting dovish US Fed policy. To capitalise on these assertions, buying the EUR/USD may be deemed viable. In the event the Eurozone performed well and the Fed cut rates, a long EUR/USD trade would likely be in great shape.
Lastly, the forex offers premier market liquidity and market growth potential―two aspects vital to maximising your profit potential. For any retail investor, these benefits are extremely advantageous when pursuing longevity in the marketplace.
Pros Of Trading Forex
The forex affords active traders and investors a collection of benefits over other markets. Below are five of the most important pros of forex trading:
The forex is open for trade on a 24/5 basis. No matter if you are interested in the world's major, minor, or exotic currencies, market access is almost always available.
Although the forex is a diverse marketplace, you have the ability to specialise via the top eight currency pairs. Known as the majors, these pairs account for 72% of total forex volume; by trading the majors, you gain direct access to the world's most prominent economies and markets.
Forex traders enjoy the utmost in financial market liquidity. Boasting over US$5 trillion in average daily turnover, there is always a counterparty for your trade.
4. Market Growth
The forex exists as a decentralised, digital marketplace. Due to its global reach, the potential for expansion and growth is far greater than that of traditional stock exchanges.
5. Profit Potential
The multitude of opportunities, simplicity, leverage and liquidity enable forex traders to pursue profits as they see fit. In forex trading, you are free to take long or short positions in foreign currencies while applying leverage in a liquid, opportune atmosphere. Each of these facets helps boost profitability immensely.
Cons Of Trading Forex
In finance, there are no free lunches; trading forex currency pairs is no different. If you're interested in becoming active in the foreign currency exchange, there are a few downsides to be aware of:
Forex currency pairs are traded on margin, thus they may be highly leveraged. And, although leverage can generate extraordinary returns, it may also bring substantial capital loss. Make no mistake, a haphazard use of leverage is ill-advised and can lead to financial catastrophe.
The forex markets are able to exhibit high degrees of volatility very quickly. Sudden fluctuations in exchange rates are not uncommon, as unexpected events frequently heighten pricing volatility. If not accounted for by strong risk management principles, detrimental price action can cause significant loss.
Forex trading is an ever-evolving endeavour, requiring constant education. The markets are always changing―what worked yesterday may not work today! To address the dynamic nature of currency trading, ongoing study and effort is required to stay in-step with the contemporary marketplace.
Is Trading Forex Or Stocks More Profitable?
If you're comparing forex and stocks, it's normal to ask the question "which is more profitable?" Realistically, the correct answer depends upon one's capitalisation, financial objectives and strategic efficacy. However, despite these factors, forex trading furnishes participants with greater capital efficiency―the backbone of achieving sustainable profitability in the markets.
When you trade the forex, you have the ability to get the most from your money. Reduced margin requirements and extended business hours allow you to implement a variety of strategies that stocks simply don't. No matter if you are a short term, day, or swing trader, you can trade more with less on the forex. Further, maximum liquidity helps you stay nimble in the market, avoiding opportunity cost. In stock trading, this isn't the case; your funds can quickly become tied up, causing you to miss profitable opportunities. Unless you deposit additional funds to meet margin requirements, positions may be liquidated and unexpected losses realised.
Given the rock-bottom margins and robust market depth, the forex offers vastly superior capital efficiency when compared to large cap or penny stocks. Trading currency pairs lets you optimise your money's potential in a fluid environment. Regardless of your account balance, or if you are a technical or fundamental trader, the forex markets are opportune avenues to explore.
Summary: Should I Trade Forex Or Stocks?
Ultimately, the decision to trade financial instruments falls upon the individual. Below are a few reasons why many traders favour forex over traditional stock market trading:
- Opportunities: Trading Forex 24/5 means you can access the market for longer than the NYSE's 8/5 operating hours.
- Simplicity: Eight major currency pairs account for the majority of market volume in Forex trading. Eight major S&P 500 stocks account for just 20%.
- Liquidity: Gauging movement in Forex could be easier due to increased market liquidity over stocks.
- Market Growth: Forex has been growing for the last 15 years whereas the stock market has returned to pre-2001 volume.
- Potential Profit / Loss: Small forex market movements can lead to large gains (or losses). The same movements with stocks can be relatively less impactful.
- Leverage: Leverage is a double-edged sword and can dramatically amplify your profits. It can also just as dramatically amplify your losses. Trading foreign exchange/CFDs with any level of leverage may not be suitable for all investors.
As with all things trading, it's important to carefully weigh the pros and cons before jumping in with both feet. Be sure to perform your due diligence ahead of entering either the forex or stock market. A bit of research can help you decide whether forex or shares trading is right for you.
FXCM Research Team
FXCM Research Team consists of a number of FXCM's Market and Product Specialists.
Articles published by FXCM Research Team generally have numerous contributors and aim to provide general Educational and Informative content on Market News and Products.
Retrieved 08 May 2017 http://www.nyxdata.com/Data-Products/NYSE-Volume-Summary#summaries
Retrieved 08 May 2017 https://www.nasdaqtrader.com/Trader.aspx
Retrieved 07 May 2017 https://www.businessinsider.com/heres-how-much-currency-is-traded-every-day-2016-9
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