Forex vs. Stocks – Which is better for you?
If you are new to the world of trading, then chances are that you might be wondering which is better, forex or stocks. One of the reasons why this question crops up every so often is the fact that investors are always on the lookout for the next market that can offer them better returns.
Ever since the 2008 global financial crisis, interest rates across some of the major economies of the world have dropped to record lows. In some economies, interest rates have been lowered to negative territory.
the traditional form of investment, such as a bank’s savings account has begun to yield little to no results.
With central banks also embarking on what has been called quantitative easing which is nothing but a fancy word for money printing to inject cash into the economy, returns even on the fixed income side has dropped.
This leaves investors to choose between trading either stocks or the currency markets. Both these markets are huge, and the returns can be quite substantial if one knows what they are doing.
Thus, when it comes to looking for the markets to trade that can get you the returns you want, traders can often end up asking the question whether forex is better than stocks trading or vice versa.
The simple answer to this question is that there is no way of telling whether forex is better than stocks or vice versa. It is simply comparing apples and oranges. Both are financial markets no doubt and certainly both are important to the economy.
You can make money trading forex and you can certainly make money trading stocks as well.
Still, many traders often want to compare forex vs. stocks to see which is a better market to trade.
There are some subtle differences between the two. What seems like a good market to trade for one trader might not be the same for the other trader. This is due to the fact that the investing goals, risk profile varies from one trader to another.
Thus, if you are simply looking to find a simple explanation for forex vs. stocks, then you would be disappointed to note that there is no way to justify which of these two markets are better to trade.
What we can do instead is point out the differences between the two which can be a good starting point.
This article aims to not answer the question of forex vs. stocks but rather lays down the facts which you as a reader can then make an informed decision about the markets.
By the end of this article, you should be able to determine for yourself whether you should trade forex or stocks.
What are the forex markets?
The forex markets deal with currencies. Currencies form an important aspect of the economy. After all, that is how nations trade goods and services and pay for these through their respective currencies.
At the core of the currency markets is the central bank’s interest rates. Investors tend to invest in an economy when the interest rates are high. This can lead to the investor making bigger returns.
What determines the interest rates is the health of the economy. Not all economies are the same. Therefore, to trade the currency markets, investors and traders alike need to focus on the economic and political developments in the nation.
A stable economy with a stable political environment can be crucial. After all, investors do not like certainty.
When you are trading the forex markets, you are basically betting or speculating on whether the currency will appreciate or depreciate in relation to another currency.
The U.S. dollar is one of the most widely traded currencies, partly due to the fact that it enjoys the status of being the world’s reserve currency. Ever since the U.S. de-pegged from the gold standard, most of the world’s major economies have free floating currencies.
The exchange rates are set by the market forces. Investors bid up or down the respective currencies based on the economic and political factors.
What are the stock markets?
The stock markets, as the same suggests is also known as the equity markets. It deals with buying and selling of shares in a company. Investors can become part owners of the company when they buy and own shares of a company.
When a company is doing good, i.e: expanding with good sales, the share price increases. Thus, this compensates the shareholder with better returns.
The stock markets are vital to the functioning of the economy. In many cases, the stock markets are closely tied to the economic performance of the nation.
However, the role of the stock markets is fairly limited. The strategies investors use, are also quite different from what you may come across when you trade the currency markets.
The economy also plays a major role in the performance of a stock market. When a government is open to foreign investment, investors can play a big role in taking stakes in a company which allows the firm to further expand their business.
The equity markets are risky. Therefore, investors are compensated for this risk by higher returns. Many stock markets around the world have a standard benchmark index which comprises of a list of top publicly listed companies.
These stock market indexes are used to measure the performance of the equity markets as a whole.
Difference between forex and stock trading
In order to understand whether forex trading is better than stocks or vice versa, let’s start by pointing out some key differences between forex and stocks. This will help you to understand and form a basic opinion about these two markets.
Forex markets are traded over the counter or OTC. There is no centralized exchange. The drawback of this is that it is difficult to understand who is buying or selling the currencies. The information available is limited.
The Stock markets are centralized and traded at an exchange. Thus, at any point you can get details on the order book which allows you to see the total transactions that take place on any given day.
Forex trading can be done on margin. Most retail forex brokers, especially those that are not based in the U.S. can offer higher leverage. In some cases, the leverage can be as high as 1:200. Using high leverage can lead to both major risks and rewards as well.
You can trade stocks based on leverage that your stock broker allows. In many cases, the leverage is very small or basically nothing. This means that the investor must put up huge capital in order to trade stocks and to make any meaningful returns.
The forex or currency markets are not regulated by any centralized agency. This is partly due to the fact that the currency markets are traded over the counter. Thus, there is a risk of a counterparty default.
The stock markets are highly regulated in all economies. The regulation ensures that there are proper checks in place to ensure that there is no market manipulation. There are many instances when attempts to manipulate the stock markets has led to legal prosecution.
When you trade the forex markets, you are basically trading one currency for another. This is also known as currency pairs. Thus, when you buy a currency pair, you are basically buying one currency and selling the other. The performance is measured by how much one currency can appreciate or depreciate against the other currency.
When you trade the stock markets, you are buying shares of the company. As a result, you are simply buying ownership of the stocks. The performance of your trade depends on how well the shares can appreciate over time.
In the forex markets, it is easy to take both long positions and short positions. This is a widely accepted practice. Due to this flexibility, you can make money even the currency pair is rising or falling. Thus, the forex markets allow you to make money regardless of the direction of the currency markets.
When you trade stocks, you are basically allowed to only buy the stocks. While you can technically short sell, this is largely frowned upon and it also incurs additional costs. Not to forget the fact that short selling can be very risky and also comes under the scrutiny of regulators.
With the forex markets, you can day trade without any restrictions. This means that you can open and close a position in a currency pair within a single trading day.
In the stock markets, rules apply if you want to day trade. This is because the regulators ensure that the markets cannot be manipulated. Rules such as pattern day trader rules comes into effect if you are a retail stock trader.
You can trade the forex markets nearly 24 hours a day and five days a week.
The stock markets are usually open for eight hours and you can trade stocks only during these regular business hours.
Is Forex Trading Better Than Stocks?
Now that you have an understanding of forex vs. stocks, let’s try to figure out if forex trading is better than stocks.
As mentioned earlier, the answer can vary depending on the type of trader or the type of returns that you expect. Thus, for some traders, forex trading is better than stocks, while for the rest, stocks are better than forex.
To figure out which of these two markets are better, you need to ask yourself the following:
Volatility: The volatility in the currency or forex markets is usually higher. This can be both good and bad. Higher volatility in the markets can mean that traders have more opportunities to make money. At the same time, the risk of losing money also increases.
Not all traders like volatility. Some traders prefer to see trends that develop gradually and are not prone to risk at all. Of course, you can find stocks such as small cap stocks which can offer the same if not higher volatility than the currency markets.
Still, on a day to day basis, the currency markets can exhibit stronger volatility than stocks which is something to consider.
Trading times: We already mentioned that the currency markets trade close to 23 hours a day and five days a week. If there is a bank holiday in one country, you can still trade the currency markets for another currency pair.
The advantage of this is that due to prolonged trading times, the forex markets are a lot easier. The stock markets on the other hand open and operate during regular business hours which spans not more than eight hours.
If you are someone who has a fulltime job, chances are that you will miss most of the action.
Transparency: Transparency of the markets is another thing to consider. The currency markets operate over the counter. Thus, there is no way of telling as to who is buying or selling.
In fact, it is difficult to predict the actual volumes that take place in the currency markets. Most of the statistics you get are just estimates. With the stock markets, it is a different story.
Since all trades are transacted at an exchange, at any given point in time, you can easily get the book details such as the number of shares that changed hands and other details such as whether the buyers or the sellers are dominating the stock markets.
Risk: The stock markets are known to be risky. When investors feel bullish, they usually bid up the equity markets. Conversely, when investors are bearish, they sell the equity markets and rush to safer assets such as gold or bonds.
With the forex markets, the risk can be seen either by the currency pair rising or falling which depicts the general market’s perception of the economy on the whole.
Capital requirements: Capital requirements is another thing to consider when you are deciding on whether forex is better than stocks. With stock markets, you generally need to have a large amount of capital to trade.
Leverage cannot be used much when it comes to stocks.
On the other hand, the forex markets can be highly leveraged. Thus, the amount of capital required to trade forex is a lot lesser. Of course, there is also the increased risk that you will lose your money, if not more due to the leverage.
Is Forex easier to trade than stocks?
A short answer to the question whether forex trading is easier than stocks is that it depends on a trader’s preferences and level of familiarity with the markets in question.
Some traders find themselves to be more adept at trading currencies than stocks and vice versa. Whether you are trading forex or stocks, chances are that you will be using fundamental analysis and technical analysis.
Most commonly, in the stock markets you will find that fundamental analysis is used. This is because, the basic premise of stocks is that you invest. On the other hand, currencies are speculative.
This while you can make quick profits day trading currencies, the same cannot be said if you are trading stocks. To achieve significant returns in the stock markets, you need to hold the stock over a year if not more.
With the currency markets this is not the case.
When it comes to technical analysis, you will always find that there is not much of a difference.
A moving average or a relative strength index oscillator behaves the same way to price whether the price is that of a currency pair or a stock.
Similarly, fundamental analysis also takes on a different approach when it comes to stocks and currencies. In the stock markets, you are more likely to use financial ratios and other fundamental comparison ratios.
With the currency markets you will be mostly focused on central bank interest rates, economic indicators and other similar data.
At the end of the day, your success will depend on how well you understand the methods of technical and fundamental analysis. Answering this question will most probably help you to determine whether you are cut out to trade forex or stocks.
Is Forex riskier than stocks?
Make no mistake. Any form of financial markets that involves speculation is risky. Losses can be seen in stocks as well as in the forex markets. There is just no way to avoid it.
In fact, if risk is something that you are not comfortable with, then neither forex nor stocks are suited for your risk profile.
Price tends to behave to the same factors and traders and investors also exhibit similar behaviors regardless of the markets that they are trading. Thus, you can see some volatile movements in both forex and stocks from time to time.
The only saving grace is that most stock exchanges around the world have circuit breakers. These are not but automated rules which can halt trading in case of adverse market conditions.
The circuit breakers help to manage risk and volatility in the stock markets to a certain extent.
When it comes to forex however, due to the over the counter nature, there are no circuit breakers. This means that traders can experience strong losses. The risk is also further accentuated when you use leverage which is common in the currency markets.
Forex vs. stocks – conclusion
In summary, the question of forex vs. stocks basically comes from the fact on how well you know these two markets. The answer is simply to stick with what you are comfortable with.
Although stock markets and forex markets might seem different, they are somewhat closely inter-related. Currencies have a major influence on the stock markets. For example, if a currency is appreciating strongly, then the profit margins for the companies start to fall as it is difficult to export goods.
A higher exchange rate can mean that nations can simply import goods from overseas which can be a lot cheaper. On the other hand, a lower exchange rate will mean that goods manufactured in the country are more competitive for selling overseas, which can impact the bottom-line results for the company.
This in turn, can influence the company’s share price. Therefore, the forex markets and the stock markets are related, and they are not completely insulated from each other.
However, the stocks do not have much of an influence on the forex markets. Unless of course, there is a major decline in the economy which can be signaled by a broad slump in the stock markets. This can foretell that the economy is slowing, which will be later evidenced by a falling exchange rate.
So while there is some amount of influence between both these markets, they are not the same as pointed out in this article. Thus, if you are more knowledgeable about accounting practices, know how to read balance sheets and able to value a stock, then you should probably stick to trading or investing in stocks.
On the other hand, if a dynamic market is what interests you and macroeconomics is something that you fancy, then the forex markets might be just the right answer for you. One of the advantages with trading the currency markets is that you can also trade foreign currencies.
But this would mean having to keep track of the economic developments in the currencies that you are interested to trade.
To conclude, both the markets have their pros and cons and there is no doubt that the risk in both these markets remain the same. You cannot expect to trade forex or stocks and expect to see less risk in one of these markets.
Your risk and investment goals also play a major role in deciding whether to trade forex or stocks. Stock market investing, as the name suggests requires a longer term horizon compared to forex trading which is mostly speculative.