Monday, June 22, 2020

Trading Stocks or Forex: The Main Differences

NBHM Research Team

Difference between Forex and Stock Trading

 

The Forex and stock markets differ from each other in many ways. Traders need to understand these differences to pick the right assets to trade.

 

 

Forex and stock trading are both popular ways to invest in the global financial markets. With the advent of robust trading technologies, it is now possible to trade in both markets from a single platform. High-speed internet connections enable comprehensive market visibility and liquidity.

Investment in any financial market is best done according to one’s trading knowledge, financial goals, trading style, risk profile and personality. Moreover, traders need to know which market works best for them, in terms of ease of entry, timings and maximising returns on investment. The Forex and stock markets have their own unique structure and characteristics, making them suitable for different types of traders.

 

Structure of the Markets

Forex trading is essentially trading one currency against another. The market is decentralised in nature, representing a network of participants globally, who conduct trades online via the OTC mode. There are many players in this global market, apart from retail traders. A huge volume of trades is conducted at the inter-bank level, with players including central banks, big investment banks and commercial banks. Hedge funds and corporations also trade Forex to manage their clients’ funds and hedge against currency risks, respectively.

In contrast, the stock market is an exchange-based marketplace. Companies raise capital by listing their shares on regulated exchanges, like the New York Stock Exchange, London Stock Exchange and Nasdaq. These shares represent units of ownership in the company. Once the stock is public, investors can buy and sell them through exchanges, which keeps track of the supply and demand of these stocks through order books. In the past, stock trading used to be done on the exchange floor, but now electronic trading has replaced most of that.

 

Liquidity

The sheer size of the Forex market makes it different from other financial markets. In April 2019, the daily trading volume in the Forex market averaged $6.6 trillion. Having such a large volume brings several advantages. For one, orders are executed more easily and this increased liquidity leads to tight spreads and low transaction costs. However, not all Forex pairs enjoy the same amount of liquidity. Major pairs like EUR/USD (Euro/US Dollar), GBP/USD (British Pound/US Dollar) and USD/JPY (US Dollar/Japanese Yen) tend to have higher liquidity than other pairs.

In comparison, the global stock market is smaller. However, this market added $17 trillion in 2019, according to data published by Deutsche Bank, seeing it approach $90 trillion in market size. The dovish stance of Central Banks globally, along with political developments, provided a major boost to equities in 2019. However, spreads remain lower in the Forex market.

 

What Makes the Markets Move?

The financial markets respond to the state of the economy and geo-political developments. Both stocks and currencies are impacted by economic releases, such as:

  • Central Bank Interest Rates
  • Inflation Rate
  • Unemployment Levels
  • Manufacturing Index
  • GDP Growth
  • Retail Sales and more

Traders in the stock markets additionally need to keep track of the company’s health, through indicators like:

  • Earnings Per Share (EPS)
  • Revenue Statements
  • Debt to Equity Ratio
  • Price to Earnings Ratio (P/E)

Currencies fluctuate in value, relative to each other, based on macroeconomic data releases. Appreciation or devaluation of currencies can impact stock prices as well. This is because for export based companies a weaker domestic currency is good for selling goods abroad. This leads to enhanced earnings and increased stock price.

For instance, a majority of companies in the FTSE 100, the index that tracks the performance of the top 100 companies listed on the London Stock Exchange, operate outside the UK. For them, a weaker British Pound could actually be a boon against a stronger US Dollar.

 

Market Hours

The FX market operates 24 hours a day, 5 days a week. Traders, banks, companies are all trading currencies continuously across the world. There are 3 major Forex trading sessions to consider:

SessionMajor MarketTime (In GMT)
AsianTokyo00:00 – 9:00
EuropeanLondon08:00 – 17:00
USNew York13:00 – 22:00

 

At specific hours of the day, these sessions overlap with each other and liquidity becomes higher during those times. The busiest times are the London and New York sessions. There is some part of the market that is always operating through the 24 hours of the day, so traders can always find counterparties to trade with.

Stock trading, on the other hand, is limited to specific hours of the day, based on the location and exchange trading times. For instance, the New York Stock Exchange operates from 9:30am to 4:00pm EST, while the London Stock Exchange opens at 8:00am and closes at 4:30pm UTC. To trade in specific stocks listed on these exchanges, traders need to adhere to these timings. In that sense, the markets are not open throughout the day.

 

Risk Level

Trading Forex involves buying one currency and selling another, simultaneously. Traders speculate on the price direction of these currencies and take positions accordingly. Assumptions are made, based on whether one currency will rise in relation to another. On the contrary, traders either buy or sell shares of a single stock.

Volatility is essential in order to get returns from the financial markets. Currencies tend to show price stability in relation to each other, when economic conditions are stable. In that respect, volatility is lower in the Forex market, as compared to the stock market. However, there can be extended periods of sharp volatility in the Forex market, especially when an important report is released or breaking news gets published.

Stocks, as an asset class, can provide higher returns over the long term, but they are risky in nature. Certain sectors of the stock market, like energy, financials and technology, can be more volatile than utility and healthcare stocks.

 

Cost of Trading

From entry barriers to spreads and transaction costs, Forex trading is cheaper than stock trading. Liquidity is also higher in the Forex market. This makes speculating on currency prices cheaper, since traders can hold positions for hours, days and even weeks.

Speculating on stock prices is also possible, but costs can run high. Many traders treat equities as long-term investments. The stock markets, despite their various ups and downs in history, have generated higher returns on investments in the long term. This is because after every market downturn, the market recovers ultimately to recoup losses.

There is no theory as to which asset is better for trading. It depends on the risk tolerance of a trader and their long-term objectives. What is similar in both markets is the need to have a proper trading plan, risk management strategy and market knowledge.

A well-diversified portfolio can contain a good mix of stocks, indices and currency pairs. Trading on a CFD (Contract for Difference) platform can allow traders to invest in various markets from a single account.

 

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