By Louis H-P on November 21, 2018Reading Time: 4 minutes
New traders can be forgiven their confusion by the bewildering amount of assets to choose from. Forex vs stocks are relatively easy to understand, giving aspiring traders a way to start their trading career! Find out what the pros and cons are of trading these two asset classes.
Forex vs stocks may seem like a punch and Judy act at times! You will find plenty of supporters and critics of both. Most investors will understand if the oil price goes up, Shell’s profits will go up too. Equally, if the UK does not manage to sign a Brexit agreement, it is a fair bet that Sterling will suffer. Or least not rise. In both cases, Forex vs stocks has highlighted how easy it is to form an opinion and place a trade.
The Forex market is one of the world’s largest financial markets. The liquidity, long trading hours and the possibility of leverage combines to be attractive to short-term traders.
Many of the world’s largest or well-known companies such as Amazon, Coca Cola and Shell are publicly listed on a stock market. Stocks are considered attractive to buy-and-hold investors because of the growth with income they theoretically provide.
Choosing where you stand on the Forex vs stocks debate will be influenced by your circumstances. Each trader has a different ability to absorb risk, financial loss and volatility. The Forex market is open 24 hours a day nearly 6 days a week. This provides you with plenty of opportunities to trade one currency versus another. If the possibility of short-term profits is attractive, then Forex will appeal. You will still need to have a good general awareness of political and economic changes. This is important as a change in interest rates will, for example, affect the value of a currency.
Short-term traders will be attracted to Forex currency pairs due to the trading opportunity that daily volatility, which moves in a small band, provides. This allows for various trading strategies such as swing, day and scalp trades to be enacted. As you are trading two distinct currencies in a currency pair, you will have to monitor policy changes in two separate countries. Forex trading is centered around a small amount of currency pairs – leaving you with a limited choice. There are four major currency pairs, all which include the USD:
Someone interested in long-term trading will want to benefit from the compounding of dividends, drawing them to stocks. This kind of trader will be comfortable with short-term under performance. This is due to their belief in the long-term potential growth of a company. As a result you be required to keep abreast of any changes in a company whose shares you own. This will include cash flows, debt levels, director changes and a change in business strategy.
Although liquidity for the large caps is not a problem, timing can be. Stock markets have set hours (typically from 8am to 4.30pm)which reduces the flexibility to trade when you want. Yet the equity market does offer a choice of venues. The US alone has several world recognised ones: S&P 500, NASDAQ, Dow Jones. Finally, indexes, via exchange-traded funds (ETFs) offer the possibility of day-trading an entire stock market.
In the case of stocks, these can easily lose 20% of value in a series of minutes after an unannounced profit warning. Currencies will tend to move less, a 1 to 2% move would be seen as large, although daily fluctuations can be more pronounced. As in all interactions with markets, be careful not to underestimate anything. When the Swiss National Bank removed its Swiss France peg to the Euro in January 2015, the currency initially fell 20% versus the Euro – losing many technical traders a lot of money.
Stocks are considered riskier due to the risk of a profit warning or a company going bankrupt altogether (think Carillion – a form FTSE market stalwart). The offer of leverage in Forex can dramatically increase the risk to a Forex trader. An account can be opened with as little as $100 whilst allowing you to borrow, increasing the size of your positions. You risk getting it wrong and losing your original capital. You also risk losing more than you actually started with. Leverage can easily blow any new trader into oblivion and debts. Be very wary of leverage if you are starting to trade.
Different trading periods of the day will affect the liquidity of Forex vs stocks. For example, in the case of currency pairs, the USD/GBP cross is most liquid between 12pm and 4pm UK time as both UK and US traders are active at the same time. The most traded currency in the world according to the BIS (The central bank for central banks), is the USD.
Fundamentally, any aspiring trader will make their choice of Forex vs stocks based on their trading strategy and risk appetite. Someone who cannot handle volatility will be best served staying clear of Forex. Someone with an investor’s long-term focus will be more suited to stocks. When choosing between Forex vs stocks, the conclusion is that both sets of traders are making money the same way. Both are trying to predict the direction of the next market move – just with different variables!