Forex and stocks are and have been two of the most popular markets for trading. While they are interlinked, there are many factors that differentiate the two. While choosing between the two, having a better understanding of their characteristics will allow one to make a more informed decision, in line with one’s risk tolerance and trading style.
A brief on forex trading
Forex or foreign exchange trading refers to the trading of currencies. Always in pairs, the price at which the exchange takes place is the value of one currency in another’s terms. Banks, travellers in need of local fiat money, and retail investors take part in this market.
A brief on stock trading
A stock refers to a portion of a company’s equity, which upon purchasing, would make you a partial owner of the entity. A stock market is a place where stocks of publicly listed companies are traded. Some companies also pay dividends regularly to their equity shareholders.
Differences between forex and stock trading
Assets involved
In most major stock exchanges, there are thousands of public company shares listed for trading. Additionally, there are derivatives such as contracts for differences (CFDs) and options available on some brokerages that increase the number of ways to trade a stock. In contrast, there are 27 major currency pairs in the forex market formed from eight different currencies. There are other non-major (minor) currency pairs traded too, but the total number does not exceed 100.
Trading hours
With the exception of some derivatives like electronically traded futures/e-minis, most stock exchanges operate for 7 to 8 hours for five days a week. For example, the New York Stock Exchange (NYSE) operates between 9 AM to 4.30 PM NYT from Monday to Friday every week.
In contrast, forex markets are open round the clock for five and a half days a week, making it a more flexible option for traders. However, this also means that price movements may occur throughout the day. Trading also tends to pick up alongside stock market trading sessions, possibly affecting the strategies taken.
Volatility
Due to its high volume, market liquidity, and longer opening hours, the forex market has a higher number of traders, meaning that it tends to see a larger and faster amount of price movement as compared to the stock market Volatility is a highly important factor, attracting scalpers i.e. short-term traders who take advantage of the quick changes in price.
Liquidity
When trading volume is high, liquidity tends to follow. With more money flowing through the market, it means that there are always a high number of buyers and sellers, making it easy to enter or exit the market.
With a turnover of trillions each day, the forex market is generally highly liquid, although there are still fluctuations with the different sessions globally.
In contrast, the stock exchange has a relatively lower turnover. Liquidity may still be relatively high for large popular companies but become significantly lower for smaller companies, especially domestic firms.
There is also a limited number of shares trading per company, and anyone who is buying or selling a significant stake can impact the market price, leaving retail investors susceptible to big price movements driven by institutional investors.
Leverage
Trading with leverage allows the trader to trade with capital that is a fraction of the position size. This is typically employed in forex trading, with ratios as high as 200:1 and margin rates from as low as 3%.
For stock trading, products such as CFDs have to be used, and even then brokers are usually reluctant to offer more than a 5:1 ratio at a high margin rate.
A double-edged sword, leverage can multiply your capital quickly but can deplete it just as fast. Hence, high-leverage trading requires prudent risk management.
Market influences
While market forces may be condensed into demand and supply, understanding that there is a myriad of factors that affect prices is key to successful trading.
In stock trading, the focus lies primarily on industry and company-specific factors such as market share, product differentiation, debt, earnings, acquisitions and mergers.
For forex trading, the factors are larger in scale as the state of the country now has to be taken into consideration. Metrics such as GDP, inflation, unemployment, as well as local and global politics play a part in influencing price. Moreover, currencies are traded in pairs, doubling the factors at play.
Which one to choose – Forex or stock trading?
Your decision to choose forex or stocks as your preferred trading instrument ultimately boils down to its suitability to your trading style. Traders and investors should consider their risk individual propensity and goals, along with the advantages of each instrument, to make the decision and find success in trading.
The article is a part of our comprehensive series on “What Is Forex Trading: A Complete Guide”.
