Both forex trading and stock trading provides investors with a diversity of investment opportunities, each with its own features, perks, and risk levels. Though they both deal with buying and selling, their major difference can be drawn from the kind of commodities they trade-forex trades foreign currencies over the counter (OTC) while stock trading is focused on trading company shares on a central exchange.
What is the Forex Market?
"The forex market is the market in which participants can buy, sell, exchange, and speculate on currencies…the currency market is considered to be the largest financial market with over $5 trillion in daily transactions, which is more than the futures and equity markets combined."
What Is The Stock Market?
"The stock market refers to the collection of markets and exchanges where regular activities of buying, selling, and issuance of shares of publicly-held companies take place."
Trading Forex Vs Trading Stocks
There are investors/traders who trade both stocks and forex, but one of the major reasons why some traders would pick forex over stock trading is forex leverage. For a new investor or trader, it may be quite tricky knowing which one to trade in. No one is better than the other, they are both financial instruments that have the potential to fetch the investor or trader more profit if played well. Though the underlying goals and risk levels of forex and stock may be quite similar they have certain dissimilarities that set them apart. Outlined below are some of the dissimilarities.
Trading Platform: In stock trading, investors or traders require a central exchange like the New York Stock Exchange (NYSE) to trade. These central exchanges provide stock traders and investors access to order-books that have records of all stock purchases and sales. With a record of all the buying and selling, traders/investors are able to analyze similar patterns that occurred on the exchange in the past and recent times. Stock traders and investors study past buying and selling patterns for different reasons one of which is tracking the exchange activity to know the best time to buy or sell a stock. While for forex trading, currencies are traded over the counter (OTC)-meaning that there is no central exchange that regulates forex as all transactions are privately done between buyer and seller.
Trading Time: Another major difference between forex and stock trading can be seen in market trading hours. Since forex has no central exchange and it spans across different time frames, it is open 24 hours. Meaning that traders can trade currencies around the clock at all forex trading sessions. The major trading sessions are New York, London, Sydney, and Tokyo sessions. Note that the forex market is only open for trading during working days and closed for trading on weekends. On the flip side, the stock market is only open for trading on central exchanges from 8 am to 5 pm daily (the time is subject to the exchange geographical location). Once the market closes by 5 pm all pending trades can only be made when the market opens the next day by 8 am. For some traders, the stock market timing stands as a major limitation.
Trading Pattern: In forex trading, currencies always quoted in pairs (e.g. USD/GBP or EUR/USD). Each currency quoted in a pair is dependent on the other. So, a forex trader is not only concerned about the financial status in the country of the currency that is being traded but also the financial situation of the country that is being traded against. Whereas, in stock trading, the trader is only concerned with the happenings surrounding the company he owns shares in. That is, if a trader owns Apple shares, he is only concerned with financial occurrences and other occurrences that happen around Apple. Whatever happens in other companies is absolutely none of his business, unless for other interests. Forex trading pairing nature requires that the trader be consciously aware of the economic standing of both countries before trading their currencies. A downside for the forex market is that it is prone to political and economic influence, unlike the stock market which is hardly affected by any socio-political and economic issues that may arise in a country.
Minimum Capital Required: For most investors, forex is a more preferable way to enter into the financial market due to the lower capital required to enter the market. Unlike trading stocks which require more capital to get started. Through leverage, forex allows small speculators or traders to enlarge their controlling units when trading. This can be both beneficial and unprofitable for these speculators. Forex trading amounts can go as low as $500, but such an amount wouldn't yield much profit compared to a forex trader who trades $5,000 daily. Compared to stocks, the minimum trading amount would be on the high side, especially if the investor desires high returns.
Leverage: The leverage in stock trading and forex trading greatly differ, and most traders prefer forex overstock for this reason. "Leverage allows the trader to buy more currencies with less cash, and when the currency's value increases the trader gains more return." In stock trading, traders are allowed a maximum of 2:1 leverage, that is, being able to make trades only twice above their current account balance. While in forex, some brokerage firms allow traders leverage of up to 50:1-allowing them to make trades up to fifty times above their account balance. 50:1 is the highest leverage in America, other countries can go as high as 400:1 leverage. High leverages may seem like a great opportunity provided to the trader, however, it also holds high tendencies of incurring losses. Leverage has the ability to increase your profits and losses, it all depends on how you place your bet.
Insider Trading: Insider trading is an act that is greatly prohibited because it gives certain investors and traders an advantage over the rest of what's supposed to be a fair market. However, the issue of insider trading is one that is still ongoing as a large number of public listed companies give room for insider trading. The category of stock traders who take advantage of insider trading work hand-in-hand with stock market insiders who have firsthand information about a company's financial position, ongoing plans for a new product line, or any other important information required to make a successful stock trade or investment. The case is not so in forex trading, though the forex market is the largest financial market, it cannot be manipulated to support insider trading because there is no central exchange and the currencies are particular to each country. If peradventure, a case of insider trading almost arises in forex trading, the liquidity and size of the forex market are able to cover any trading pressure that may come from insider trading.
Commissions and transaction costs: Forex is considered as one of the easily accessible financial markets because of its low commissions and transaction costs. Some forex brokers run commission-free services but get their fees off the bid-ask spread. While other brokers charge upfront commissions. In the stock market, some brokers may decide to generally charge low commissions and transaction fees while others may charge according to the type of investment made and the risk level.
Tradable Instruments: When it comes to the number of available tradable instruments, the stock market beats the forex market. The stock market gives traders and investors a wide variety of investment options-the New York Stock Exchange alone has about 2,000 listed stocks whereas the foreign market provides its traders with a variety of only eight major currencies. The major currencies include the US dollar (USD), Euro (EUR), British Pound (GBP), Canadian dollar (CAD), Swiss Franc (CHF), New Zealand dollar (NZD), and the Japanese yen (JPY). The major currencies form the major pairs which make up about 72% of the forex volume. The overall number of forex pairs are nothing compared to a number of accessible investments that can be made in the stock market. On the contrary, the stock market may have the advantage of providing investors with multiple investment options, however, it is quite easier to control fewer currencies or shares compared to controlling a large base. It would then be preferable for stock traders to channel their focus on the shares of a particular industry for better monitoring and control, rather than having multiple shares from various industries.
Presence of Middlemen: Since forex, trades are done over the counter, and transactions made directly between the buyer and the seller, there'd be no room for a middleman. Unlike stock trading which requires the services of a middleman which is a stockbroker. Stock traders or investors can only access the stock market through their brokers which serve as an intermediary in processing all transactions by routing or "buying and selling orders to match the best possible prices on the market."
Pros & Cons of Forex Trading
Like most financial vehicles, forex trading also has its perks and threats. It is advisable for individual investors to first weigh the benefits and possible disadvantages of forex before engaging it. It is also important to know that forex is not necessarily an investment vehicle but merely a currency trade that holds the potential of bringing in a profit. The forex market is the largest and most accessible financial market there is. It only takes traders about 1 -3 days to set up and account and fund it with at least $500. Forex trading is done OTC directly between the buyer and the seller, but you can also choose to trade through a brokerage which can be done online. Online forex trading provides traders with real-time market pricing, price charts, news, and tools. The forex market is always open 24 hours, 5 days per week; therefore, traders have the liberty of trading at any time of choice. Forex leverage is another important feature that attracts many investors. Its availability is greater than most markets and traders in the US can access up to 50:1 leverage. If played well, forex has a potential for yielding high returns as the returns are received daily. However, due to having no central regulatory body the forex market lacks full transparency, unlike the stock market. Since trades are direct, a trader may not get the best prices or have control over how his trade order is executed. He also may have limited views on the trading quotes presented to him by his broker. To avoid this, traders should opt for regulated brokers found within the group of broker regulators. There are also no fixed prices as the price of a currency can be determined by how much the traders are willing to negotiate. Unlike the stock market which is rarely affected by external forces, the forex market can greatly be affected by governmental or economic issues in the currency-holding countries. Traders ought to be concerned about the economic downturn of the countries of their paired currencies.
No middleman or central regulator
Fast returns potential
Supports easy short selling
Lower chances of insider trading
Lesser commissions and fees
Simplified tax rules
Small traders may suffer some losses
Lower residual returns
No official regulatory protection
Pros & Cons of Stock Market
Investing in the stock market is a great way to make money in a short time if you play your cards right. It is also important to note that any investment with high potentials of bringing in quick returns would also come with a significant level of risk. Compared to other investments like bonds, CDs, and real estate, investors can easily buy or sell stock as they deem fit, and as well have easy access to their money without having to wait for a very long time. In as much as the stock market offers quite some advantages to its investors, its major threat is crashing. In 2008, the stock market crashed in only a few hours and a whole lot of investors were badly affected. It didn't take until years before most of these investors were able to recover from the shock and rebuild their portfolios. Also, its high volatility makes it that those who bet well win so much money, and those who do not bet well lose all their money and watch their investment go down the drain in just a matter of time. Investing in risk is for those with high-risk tolerance and solid financial stability.
Part ownership of a company
Risk of a company going bankrupt
Stock market crash
Fall in shares price
High commissions and charges
As earlier stated, no financial market is better than the other as both the forex market and the stock market have their benefits and risk levels. The result of trading stocks or forex is dependent on how well the trader understands the market and uses it to his advantage. The choice is completely up to you as an investor or trader. What we have been able to do is highlight major differences in both trades that can help you figure out which one works better for you. There are many traders who trade both forex and stocks successfully. For beginners, forex trading may be a good starting point to get into the financial market as forex trading holds substantial advantages such as leverage, lower commissions and transaction costs, favorable trading times, no middleman interference, absence of insider trading, and lower starting capital. Once a certain level of mastery has been gained about how the forex market works, the novice trader can move into stock trading, and at the end of the day compare which one works better for them.