Nowadays, investors have access to an ever-increasing number of trading instruments, including blue chips, indices and Forex markets, so choosing which market to trade is not always an easy decision. For this reason, traders need to consider a number of factors in order to make the best choice.
Probably one of the most important aspects is a trader's risk tolerance and their style of trading. For example, long term investors may be more suited to trading the stock market, whereas short-term traders may prefer markets where the effects of price volatility are felt to a greater extent. This article examines the differences between Forex and stock trading and discusses why the majority of traders usually opt for trading Forex over stocks.
The Difference between Forex and Stock Trading
The main difference between the Forex and the stock markets is the number of trading alternatives available. The Forex market has just a few options compared to the thousands that can be found in the stock markets. Since most Forex traders focus on the 4 major currency pairs (i.e. EUR/USD, USD/JPY, GBP/USD and USD/CHF) it is clear that currency trading is easier to follow. Rather than having to choose between 10,000 stocks to find the best value, Forex traders are more focussed on staying up to date on the economic and political news of the countries in question. Finding success in the stock market can therefore be a harder task and would explain why so many traders across the world choose Forex.
The Advantages of Forex over Stock Trading
There are several reasons why traders would want to look at Forex rather than "traditional" stock trading and these are as follows.
Manageable Amount of Trading Choices
The ease of choosing a currency to trade instead of choosing from thousands of stocks is one of the key factors. Stocks can decline even in a bull market if it's not the best stock in its peer group or if a trader is not in the right sector. Quite often, a sector or stock will fall even as the general market rises, so an investor needs to be very good at choosing stocks or just plain lucky.
The currency market with its far fewer choices makes a trader's job much simpler. As we have seen, most Forex traders stick to the major pairs and it is a fact that most currency trading is between the euro and the US dollar. Even leaving EUR/USD aside, there are only a few other major pairs and by watching those, traders are essentially watching the world. Even if a trader expanded their Forex trading into other types of currency pairs, it is a drop in the ocean compared to the tens of thousands of stocks that exist. Hence, in this respect, currencies are easier to follow.
Currency markets are much larger than equity markets, with the daily trade volume in Forex estimated to be as much as 10 times larger than the combined volume of all of the world's stock markets, making it a very liquid market. Due to the high liquidity of the Forex market, margins are low and leverage is high. It is not possible to find such low margin rates in the stock market as the majority of margin traders need to have around half the value of their investment in their margin accounts. Forex traders, meanwhile, only require an amount as low as one percent.
The Forex market is a market that trades around the clock. This means that if the price spikes after hours and you are a short-term trader, you can adjust your existing position or enter a new one without having to wait until the market opens the next morning. Forex market liquidity stays deep for most traders around the clock; there are of course, moments when currencies are less liquid, but for most participants, liquidity is fine even then. Spreads also stay tight with the euro-dollar exchange rate typically being 2 pips or less and although they may go to 3 pips when liquidity is not as high, there is rarely a major widening in spreads.
Flexibility to Go Long and Short
Forex offers the flexibility to go long and short with ease which doesn't happen with stocks. Trading opportunities exist with Forex regardless of whether a trader is long or short, so traders always have equal access to trade in a rising or falling market. Stock markets on the other hand can frequently hit a lull, resulting in declining volumes and activity, making it difficult to open and close positions when a trader would like to. Furthermore, in a declining market it is only with extreme dexterity or luck that a stock market investor can make a profit. Forex offers the opportunity to profit in both rising and declining markets as, with every trade, a trader is buying and selling at the same time and short-selling is, thus, a part of every trade.
The Forex market experiences a lot of volatility which is ideal for aggressive traders. In addition, currencies are also well-known for staying with the trend for a long time, despite their volatility.
Commissions in the stock market tend to be a lot higher than in the Forex market. Traditional stock brokers charge commission fees on top of their spreads, as well as fees that have to be paid to the exchange. Most Forex brokers do not charge commission or additional transaction fees to trade currencies online.
Generally speaking, Forex trading costs tend to be lower than in other markets and the majority of brokers receive payment for their services by means of the bid/ask spread.
Overall, there are several reasons why traders often prefer to look at Forex rather than stock trading. Quite simply, the benefits of trading currencies in the globally accessible Forex market are huge and outnumber those of stock trading. Ultimately though, it is a matter of a trader's personal preference and risk tolerance.