The forex (foreign currency exchange) market is the largest and most liquid financial market in the world. The forex market unlike stock markets is an over-the-counter market with no central exchange and clearing house where orders are matched.
Traditionally forex trading has not been popular with retail traders/investors (traders takes shorter term positions than investors) because forex market was only opened to Hedge Funds and was not accessible to retail traders like us. Only in recent years that forex trading is opened to retail traders. Comparatively stock trading has been around for much longer for retail investors. Recent advancement in computer and trading technologies has enabled low commission and easy access to retail traders to trade stock or foreign currency exchange from almost anywhere in the world with internet access. Easy access and low commission has tremendously increased the odds of winning for retail traders, both in stocks and forex. Which of the two is a better option for a trader? The comparisons of retail stock trading and retail forex trading are as follows;
- Nature of the Instrument
The nature of the items being bought and sold between forex trading and stocks trading are different. In stocks trading, a trader is buying or selling a share in a specific company in a country. There are many different stock markets in the world. Many factors determine the rise or fall of a stock price. Refer to my article in under stock section to find more information about the factors that affect stock prices. Forex trading involves buying or selling of currency pairs. In a transaction, a trader buys a currency from one country, and sells the currency from another country. Therefore the term “exchange”. The trader is hoping that the value of the currency that he buys will rise with respect to the value of the currency that he sells. In essence, a forex trader is betting on the economic prospect (or at least her monetary policy) of one country against another country.
- Market Size & Liquidity
Forex market is the largest market in the world. With daily transactions of over US$4 trillion, it dwarfs the stock markets. While there are thousands of different stocks in the stock markets, there are only a few currency pairs in the forex market. Therefore, forex trading is less prone to price manipulation by big players than stock trading. Huge market volume also means that the currency pairs enjoy greater liquidity than stocks. A forex trader can enter and exit the market easily. Stocks comparatively is less liquid, a trader may find problem exiting the market especially during major bad news. This is worse especially for small-cap stocks. Also due to its huge liquidity of forex market, forex traders can enjoy better price spread as compared to stock traders.
- Trading Hours & Its Disadvantage to Retail Stock Traders
Forex market opens 24-hour while US stock market opens daily from 930am EST to 4pm EST. This means that Forex traders can choose to trade any hours while stock traders are limited to 930am EST to 4pm EST. One significant disadvantage of retail stock traders is that the stock markets are only opened to market makers during pre-market hours (8:30am – 9:20am EST) and post-market hours (4:30pm – 6:30pm EST). And it is during these pre-market and post-markets hours that most companies release the earnings results that would have great impact on the stock prices. This means that the retails traders (many of us) could only watch the price rise or drop during these hours. Besides, stop order would not be honored during this times. The forex traders do not suffer this significant disadvantage. Also, a stock trader may supplement his/her trading with forex trading outside the stock trading hours.
In order to trade stocks, a trader needs to have quite a significant amount of capital in his account, at least a few tens of thousands in general. However, a forex trader can start trading with an account of only a few hundreds dollars. This is because forex trading allows for higher leverage. A forex trader could obtain larger transaction compared to stock market. Some forex brokers offers 100:1, 200:1 or 400:1. A leverage of 100:1 means that a US$1k in account could obtain a 100 times transaction value at US$100k. There is no interest charge for the leveraged money. Stock trading generally allows for not more than 2 times leverage in margin trading. There are interest charges associated with margin trading.
- Data Transparency & Analysis Overload
There are thousands of different stocks in different industries. trader needs to research many stocks and picks the best few to trade. There are many factors that affect the stock prices. There are much more factors that may affects stock price than foreign currency exchange rates. The forex traders therefore can focus on few currency pairs to trade. On top of that, most data or news affecting currency exchange rate are announced officially, scheduled and in a transparent manner. Retail forex traders therefore have better chances of success than retail stock traders.
- Bear/Bull Stock Market Conditions
Forex traders can trade in both way buying or selling currency pairs without any restrictions. However, stock traders have more constraints to trade and profit in bear market condition. There are more restrictions and costs associated with stock short selling. In a bull market when the economy is doing well, stock traders have a high chance of profitability if they buy stock first then sell it later. Savvy forex traders however, could operate in all market conditions.
- Trending Nature of Currency
Major currencies are influenced by national financial policies and macro trends This national financial policies and macro trends tend to last long in a certain direction, either in monetary expansionary (rate cutting) or monetary contractionary cycle (rate hiking cycle). Stock prices however tend to fluctuate up and down due to many factors, many of these factors are micro and specific to the stocks. Therefore forex traders can better exploit the trends in foreign currency markets that stock traders in stock markets.
Generally, most major stock markets are better regulated than forex markets. Therefore, traders need to be aware of this difference to stock markets. Fortunately, there are however many reputable forex brokers in the market. With prudence and proper research, it is not difficult to find a suitable reliable forex brokers.
Based on the above few points, forex trading seems to be a better trading option than stock trading, especially during these uncertainties in the global economy. During bull market condition, stock trading could be a viable alternative. A stock trader should definitely seriously consider supplementing their trading with forex trading. Forex trading enables a stock trader to exploit any opportunity arises during non stock trading hours, by trading in forex trading. Forex trading would also enable the stock traders to understand a more complete big picture of world economies operations and further enhance their stock trading skills.