Trading forex and stocks are quite similar to each other in that the constantly altering market prices determine them both, but that is where their resemblances end. It is crucial to comprehend the fundamental disparities between stock and forex trading so that you can settle on the type of trading that would be preferable to your goals.
In this guide, we cover the fundamentals of the two markets and see how they differ.
Similarities between forex and stocks
Forex trading necessitates the exchange that includes buying and selling the currencies of two different countries, whereas stock trading involves buying and selling shares of companies. Both involve some type of exchange on markets.
Both take advantage of shifts in prices over the short-term to make profits. The risk involved in each of them entails that the holding currency or stock may fall in value instead of rising after the purchase.
Additionally, both markets depend majorly on different forms of technical analysis. These facilitate traders to determine potential movements in price and dictate how they should behave. Both types of trading also require an understanding of the market function and enough practice to generate profit consistently.
Differences between forex and stocks
Now, let us move on to the chief points of distinction between the two forms of trading to better grasp which one is ideally suited to your needs.
Volatility and liquidity
Usually, there tends to be more volatility in stocks than in the forex market. During the times of economic certainty and stability, currencies stay generally stable relative to each other. For instance, the annual volatility of SP500 is around 18.1%, while that of EUR/USD hovers around the 3%-4% mark. But, this doesn’t always happen, and even the forex market has seen multiple periods of high volatility. These may or may not relate to high periods of volatility in the stock markets.
On the other hand, the forex market has high liquidity as compared to the stock market. It is because of the forex market trades in high volume. Also, the major forex pairs generally have low transaction costs and tighter spreads as opposed to stocks.
The scope of what a trader has as his/her focus is another significant difference between stocks and forex. One doesn’t have to concentrate on many variables when looking at a single share. Even though you may be considering a few broader trends, those determinants that directly affect the company would be more critical.
Metrics that are relatively narrow that highlight the company’s state will be chiefly important, such as the ones mentioned below:
- Investor confidence and expectations
- Price to earnings ratio
- Revenue Growth
- Stock market growth
- Interest rates
The focus is slightly complex with forex. A whole economy’s performance is reflected by a currency, which is why traders need to be well-versed in macroeconomics.
Their focus tends to be on:
- Interest rates
- Bond auctions
- Global Trade and Commodities
Since forex trading involves the simultaneous buying and selling of two currencies, a trader has to factor in both the economies and their relationship.
The forex market has its major participants spread across the globe with no centralized system, so its trading is available around the clock. For instance, the NYSE trading session opens at 09.30hrs and closes at 16.00hrs local time. The most liquid trading hours are when the New York session overlaps with the London session, which is when the EUR/USD pair (the most traded currency pair) is exchanged. This is from 1300hrs to 1600hrs GMT.
On the other hand, stocks have a stricter timeframe for trading, which is also possible only on weekdays. All traders dealing in stocks have to comply with the stock exchange hours.
The main reason why forex trades at all times is that it doesn’t have a centralized physical exchange location and takes place mostly over communication networks. It is also important that such remains the case for trading worldwide as currencies are in flux around the globe and in continual demand. But, stocks tend not to be in such a high demand once the business hours close and it doesn’t seem practical to keep them open beyond those hours.
Margin and Leverage
One major advantage that forex has over stocks is that the former offers amazing leverage to its brokers. Those who trade stocks are doing so with 1:2 or 1:4 leverage intraday if your account meets “pattern day trading rule” requirements. Traders can trade margin using CFDs if they trade stocks, and the best leverage that they can get is 1:10; forex brokers, on the other hand, get offered 1:50 leverage.
Margin and leverage offer the convenience of commanding a much larger position for a given deposit. But, it is equally crucial to be aware of the size of the actual position and the risks involved with it. Leverage can be quite a powerful instrument but, when not managed properly, can also put a full stop to your trading career.
The size difference between the two markets is quite immense as well, with the forex market being the most voluble market in the world that sees trading over 6 trillion US dollars every day. The combined size of all the world’s stock markets equals 200 billion USD. It is but a fraction of the forex market’s volume.
Most of the forex liquidity is concentrated around a few currency pairs, such as:
Such a huge volume can be highly advantageous to traders since voluble trades are easier to execute and also remain closer to the intended price points.
Which is better for you?
Choosing to trade one or the other will be determined solely on the trader’s goals, on his/her trading style, and risk tolerance. Forex trading is much less regulated and has much more leverage than stock trading, which can present high potential profits and high risks.
It is also easier to track the forex market as there are only a few common tradable currency pairs (18 in all) compared to hundreds or thousands of stocks. The all-day forex trading can be a notable drawback as you may have to work at odd times to ensure some trades are realized. Additionally, the markets are always changing, even if you’re not working.
Both forex and stock trading have their own sets of benefits and drawbacks. Though they have a few similarities, they differ greatly in multifarious ways. A trader should choose one or the other after a thorough study of both of them and determine which is the ideal choice for him/her.