Forex or Stocks: Which of the two should you trade?

Sep 25, 2020

While the FX market is the biggest financial market in the world, the stock market has been a popular trading battlefield for investors for years. People who are new to trading often wonder which is better. To be frank, there is no quick or easy answer to which of the two is best. There advantages and disadvantages when trading both.

Firstly, let us ask ourselves an important question – why do people turn to trading in the first place?

If you believe that forex trading is a simple and fast way to earn money, you are unfortunately mistaken. Forex trading, as any kind of trading, requires knowledge, attentiveness, discipline, and most importantly patience.

In most major economies, there are low-interest rates on savings, meaning that all your hard-earned active income will sit in a bank and not significantly increase. In fact, in many large economies, interest that is paid on savings is less than the rate of inflation. Due to this, people started looking for better opportunities to invest their money in, and this where trading stock and currency pairs come in place.

The Big Bad Forex Market

As we mentioned before, the forex market is huge and is in fact the larger financial market in the world. The FX market is decentralized, and it determines foreign currency exchange rates. It consists of a large network of major players (or traders) such as investment banks, central banks, commercial businesses, and hedge funds. The main participants in the forex market are large international banks.

Currencies are always traded in pairs as the forex market does not determine a currency’s absolute value but instead, it’s relative value. It does this by setting a market price for one currency if it’s paid for by another.  Foreign currency exchange is crucial for international trade as it enables currency conversation. There is actually little cross-border regulation in the currency market. Due to their over-the-counter (OTC) nature, there are multiple interconnected market places where various currencies are traded.

Over $6 trillion are traded on a daily basis; the forex market does not have one central location, since there are participants from across the world. It operates on a 24-hour basis, 5 days a week.

The Wolves of Wall Street – The Stock Exchange

The stock exchange, unlike the FX market, is not a single facility. Securities as well as other instruments are traded on stock exchanges like the New York Stock Exchange (NYSE), NASDAQ, Bombay Stock Exchange (BSE), London Stock Exchange (LSE), Shanghai Stock Exchange (SSE), Euronext, and others. Stocks or shares of a company reflect the ownership of equity in the company. Shares are held by shareholders who hold voting rights and earn corporate earnings such as capital gains or dividends on the profit generated by the company. Institutional and retail investors will come to purchase and sell public shares.

Mostly, transactions are done on stock exchanges. Many businesses opt to float shares of their stock in order to raise capital. Stock exchanges provide a controlled, transparent, and accessible environment for buyers to trade shares with sellers. Conventionally, trading on stock exchanges was performed by “open outcry,” but in recent years more traders have chosen to turn to online trading.

What is the difference between the two?

Trading hours: One core difference between the two markets is that the FX market works on a 24-hour basis and has no centralized location. This means that participants are spread worldwide so there is always a part of the market that is trading. Stock trading is different because traders need to follow the trading hours established by the stock exchange. To combat this limited timing, some exchanges have introduced extended trading hours. This allows stock traders to participate in pre-market and after-market trading.

In the past, extended trading sessions were only available to institutional traders. In recent years, online trading had developed enough to allow retail traders to participate in these sessions too. Extended trading sessions are non-liquid and low volume.

This is why trading forex is preferred by so many traders, particularly retail traders. It opens opportunities to participate in a wider timeframe and offers access to larger volumes. On the other hand, a market that’s moving 24 hours a day can be difficult to monitor and can result in higher risk.

Liquidity and Volume: The FX market is substantially larger than the stock market, despite its popularity. The bigger the market, the more liquid it is. Liquidity makes it easier to trade a financial instrument and equates to tighter, more proportional spreads with lower transaction costs.

Market liquidity fluctuates as different sessions close and open across the world. Market liquidity and volume highly depend on which currency pair you trade.  The most liquid currencies are majors that are accountable for the majority of the trading volume. The USD is involved in over 70% of all forex trades across the world. Some large stocks are highly liquid, such as blue-chip stocks like Microsoft, Apple, Vodafone, and Facebook are much more popular yet the stock market sees much less.

Volatility: High market volatility is when an instrument’s price changes rapidly; low market volatility is when it changes gradually. The forex market is particularly volatile, so it’s important to keep up with factors that could affect it such as political and economic events.

The stock market tends to respond drastically to global events. For example, when COVID-19 was declared a pandemic global financial market plummeted drastically. Markets tend to react more to domestic events, which is why Asian stocks declined first.

Market influences: Both the stock and the forex market are deeply influenced by supply and demand. Share prices are directly impacted by the factors that affect their industries. Currencies tend to get more affected by macroeconomics; factors like inflation, unemployment, and GDP tend to immensely influence forex prices. And because currencies are traded in pairs, investors must be aware of how both countries perform economically.

Leverage and Margin

One great advantage of trading forex versus stocks is that great leverage is offered. Usually, when trading stock physically, you are unlikely to benefit from leverage. Only by trading CFD stocks can traders benefit from trading on a margin, and at most the leverage will be 1:10. Forex brokers will often offer as much as 1:50 leverage; 1:30 for retail clients and 1:500 for professional clients.

It is important to remember, however, that trading with leverage involves risk. Leverage can be highly advantageous when trading but can also severely damage the portfolio of an inexperienced trader.

Conclusion

So, which is better – forex or stocks? The answer is neither. The most important thing in trading is to do what works. Whichever market interests you better and you feel you understand better is better to go with. Traders who are more interested in macroeconomics may prefer to speculate currencies. Those who have a particular interest in large, individual companies are most likely to turn to stocks.