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Is Forex Trading Better Than the Stock Market?

Is Forex Trading Better Than the Stock Market?

Over the past 12 months, Forex trading has seen a bit of a renaissance, with lots of Forex trading firms and projects taking hold among the community. It looks almost as if the market had suddenly become popular and everyone was jumping in, with more people taking to day trading.

In all cases, brokers talk about Forex day trading as the best way to raise your income or even get a new, simpler full-time job. Yet, it’s easy to wonder, how true is it that Forex is the best way to make money in the investment market? Wouldn’t it be better to just play the stock market, as many people do? As it turns out, there are key differences that make both markets unique.

Stock and Forex Trading Compared

In comparing stock and forex trading, there are several talking points to consider. Although we see the stock market as the be-all, end-all of trading markets, in truth no stock market can hold a candle to the Forex market in sheer size. While the stock market trades about $200 billion per day, a staggering amount wherever you put it, the Forex market goes even higher, averaging $5 trillion per day. That’s more than several tens the magnitude of the stock market.

While sheer size might not tell us much at first, it matters a lot – particularly once we also consider that the Forex market is highly liquid. A large trading market with high liquidity means it’s much easier for anyone to enter or leave the market, since the expectation is that whenever you want to trade there will be somebody willing to trade with you.

Let’s take a look at an example of how market size and liquidity work with forex compared to stock market:

In the stock market, you have a number of stocks in your portfolio. Let’s say those stocks are divided 50/50, with half belonging to company A and half belonging to company B. One day, Company A’s CEO goes to jail because of a scandal involving a giraffe and a pair of tweezers, bringing the overall trust in the company down.

You hurry to try and sell your stock, only to find that this scandal is large enough that nobody wants to purchase them. You’re left with dead stock, hoping Company A eventually recovers. You can’t trade it nor turn it into liquid, since nobody will buy. Trading A stocks for B stocks directly isn’t even an option.

Now let’s look at a similar situation in the Forex market:

You have invested your life savings in Forex, and now half your money is in GBP, while the other half is in JPY. One good day the prime minister of the UK resigns over a scandal involving a box of eggs, fungus medication, and a teacup. The GBP plunges.

As soon as you read this, your instinct is to switch your savings to another currency since this is a scandal that will affect the UK economy for years to come. You enter your Forex exchange, look for people trading GBP/JPY and… there it is, somebody is doing it.

There’s somebody out there who has decided to bet on the GBP rebounding, and thus buying the currency now that it’s low. Even if there wasn’t, you could always run and spend your savings in GBP on something else (like the stock market) without needing anyone else for it, because GBPs are liquid.

See the difference? When trading values, market size and liquidity matter above everything else. Larger markets mean that more people will be trading, thus raising your chance of finding somebody willing to buy from you so you can jump out. Moreover, since the market is liquid, you always have the option of spending it. People all over the world will take GBP even in the midst of a huge scandal. Banks will trade it, accept it, and exchange it. Now try using Netflix stocks to pay for eggs and milk and see how that goes.

The Forex Market Works Round the Clock

Another key difference when comparing shares vs stocks is when you can trade. The stock markets typically work only during the day, five days a week – although after hours trading has slowly become more of a thing. This means that if anything takes place during the night you can’t really assess how good (or bad) it is until the morning, when the markets open.

The above scenario also means that your ability to trade in foreign stock markets is limited, since your daily schedule and that of those markets might not line up well. This doesn’t mean it’s impossible to trade in foreign stocks, but it is much more difficult than it should be.

Forex market, on the other hand, is global. Usually these markets open during daytime hours, five days a week, but, thanks to the magic of time zones, it’s always daytime somewhere in the world. So, for five days a week (and a bit more, once again thanks to time zones) there are people trading round the clock.

Naturally, trading volumes and currencies change during the day both thanks to the market itself and thanks to the local times of the countries those currencies belong to, leading to better and worse trading hours depending on your trading pairs. Chinese Yuan is naturally traded more during the hours when Chinese exchanges are open, particularly during Chinese peak time. However, you can also trade at odd hours – it might just take a bit more effort to find someone matching your pair.

Some currencies are even traded round the clock too. Currencies that are considered international, like the USD, see decent trading volumes at all hours. So do other large currencies (JPY, GBP, EUR.) They have peak times, but you can find trading pairs against those at any time, leading to a market that’s accessible wherever you are.

Smaller Commissions and Prices

When trying to compare day trading forex vs stocks, this is a big one. While all markets charge trading fees, the stock market often imposes much higher ones than the Forex market – partly due to the lower value per unit, and the attendant high liquidity.

While most stock markets will charge fees based on a set percentage of the traded value, Forex market instead works on pips, that is, a percentage point of the currency value, with most trades happening with a 2-3 pip commission, and some even going as low as a single pip.

These smaller commissions naturally lead to better earnings, since you lose a lower part of whatever you make on them. This is particularly good when we take day trading to account.

Taking Decisions By The Day

Again, by nature, forex is designed to function on day trading terms. The underlying driver here is that most businesses have to make daily decisions that drive their set goals. Whether it is sourcing scarce skills or core inputs for production, there are funds set aside to chase these vital components of corporate wellbeing. As such, at some point, that buying decision is taking place somewhere in the world.

Since countries and national borders decide the currency in use, you should expect that the demand for a particular currency will be driven by a variety of factors. For example, on a day that the Feds announce that interest rates remain unchanged, you can expect forex traders to keep their spreads. This will not be the same if the Feds agreed to raise interest rates. The USD will strengthen when interest rates rise as more American investors might explore investing their funds in the country than overseas.

So, USD pairs will yield more with a scenario above than otherwise. A forex trader cannot, however, maintain a fixed position every day. If he does, the risk of massive losses will rise. In the same vein, with the past reports of the US-China standoffs, the USD did weaken as fears of a global meltdown surfaced. As soon as reports emerged that the standoff was getting some salve, the USD began to rise again.

In the face of disruptive market actors, forex traders have to respond to the developments on a daily basis and set their trades as such. On the other hand, stocks can be held over a quarter, a year, or more on the basis of expected performance and surge in capital gains. In the interim, it might not matter whether there is a temporary market ruckus between countries. Since it is likely that such will not endure for so long, a stock trader might rather just keep abreast of the news to be up to date rather than sell.

If a settlement between the disagreeing parties is reached before long, you will find that the stock price might surge when year-end results are declared. If there are any effects on earnings for the period, it might be inconsequential as to affect the dividends declared and paid for the year.

Day Trading: Inherently Better in Forex

When it comes to day trading, there’s no need to compare trading equities vs forex. Forex is automatically the winner, for a few reasons.

First, the smaller commissions, as mentioned above, give you a better rate of earnings per trade. When day trading, you’ll find yourself making huge trades of potentially thousands of dollars (or pounds or euro) each – and the savings from lower commissions will add up. A percentage point might not seem much on a single, small transaction, but when you trade dozens of thousands of dollars in a day, that percentage point is suddenly a three-figure number and large enough to matter.

The second reason why comparing day trading forex vs stocks leads to a single, absolute winner, is related to laws: At least in the US, authorities are lax with regulating Forex day trading practices compared to stocks. In fact, day trading the stock market in the US is so tightly controlled that many find it simply impossible to perform it successfully. Rules about how much you can invest, the minimum you need to invest, and even how much equity you can receive create a very restricted market.

The forex market is much laxer in this regard, even in the US. First of all, there is no minimum set to participate: You can trade forex on a $100 equity if you so wish. In fact, forex trading is so easy that anyone can just create an account and trade – this being one of the reasons why forex trading has grown so popular, while stock trading still seems complicated and difficult for most.

Then there’s leverage numbers: The max leverage you can get in the stock market in the US is 4:1. For forex, however, traders can use leverage of up to 50:1 in the US, and even higher in the rest of the world – with the standard being 100:1, and some traders even going well beyond that. Higher leverage naturally means more investible funds, which in turn multiplies your earnings accruable.

Stock Markets Have More Options

This is the one point where, when comparing forex vs stock exchanges, the stock market wins hands down. In a stock market, you can trade shares of many companies that are publicly traded and listed there. Some markets, like the NY stock market, can carry thousands of different shares, all of which you can invest in if you have the money and interest.

This isn’t true for forex in general. While trading in less- used currencies has become a thing recently, it’s still not widespread enough – so most forex trades involve only eight different currencies, known as the eight major currencies. This list includes the USD, CAD, EUR, GBP, CHF, NZD, AUD, and JPY. It’s not that other currencies can’t be traded – they’re just nonstandard and therefore they aren’t offered everywhere.

Bullish Stocks? Not for Forex

Ever heard of a bull market? Or a bear market? It’s a term used in investment circles to denote a market where values are going up without control, causing a potential bubble (bull market) or where the opposite is happening – a market where a commodity or value is quickly losing all its weight.

While currencies do gain and lose value every minute, there are huge limits to how much a given currency can appreciate or depreciate vs its trading pairs within a timeframe. It’s not a legal limit, but a market one – there’s always a point where markets revert, barring a catastrophe that completely erases trust in a currency.

This severely limits how much money a trader can earn from them, because the market tends to correct itself since currencies are tied to their countries’ own economies. Also, since bull and bear markets tend to develop at intervals, they are hardly in tune for day trading, or at least, not to the extent that you could if you went for mid-to-long term investments.

Another thing to keep in mind is that, since forex trading happens always in pairs, whenever a currency’s value starts going down, another currency’s value has to go up. So, in terms of relativity, currencies might be more inverse in behavior to be of benefit to the trader.

Which one should I choose?

There’s no clear answer as to whether it’s better to go for forex or the stock exchange. Both have their strengths and weaknesses, and in truth, which one is better will depend on your investment goals.

That said, the unique strengths each have will determine which one you should go for. If you want to do long-term trading, then the stock market is clearly the place to be. Shares appreciate more often than currencies and are definitely a much wiser long-term investment than fiat. On the other hand, if you want to play the market, then forex might be the ideal place for you. This is partly attributable to market size – and also, because of how leverage works in forex vs the stock market.

Nevertheless, day trading is possible in the stock market, and companies do keep money saved in different currencies as a buffer for foreign exchange losses. This is as a result of having global operations with several payments going into multiple countries at a time. Each market might be better suited for one person or the other, but for a retail investor looking at short term gains, forex trading trumps the stocks.

 

References

  1. https://money.howstuffworks.com/personal-finance/financial-planning/how-to-start-investing1.htm
  2. https://www.fool.com/knowledge-center/bull-market.aspx
  3. https://www.investopedia.com/ask/answers/06/maincurrencypairs.asp
  4. https://www.fool.com/how-to-invest/return-on-equity-leverage.aspx
  5. https://www.thebalance.com/day-trading-restrictions-on-us-stocks-1031352
  6. https://www.fool.com/knowledge-center/how-to-calculate-foreign-exchange-gains-or-losses.aspx
  7. https://www.investopedia.com/articles/forex/05/tradingonnews.asp
  8. https://www.forbes.com/sites/panosmourdoukoutas/2019/10/12/trade-war-with-china-what-is-america-up-to/

Author Profile

Fat Finger

Fat Finger

Hello everyone!

My name is Phat Fin Ge, but most people just call me Fat Finger or Mr. Finger.

Many years ago, I was a trader on the Hong Kong Stock Exchange. I became so successful that my company moved me to their offices on Wall Street. The bull market was strong, but my trading gains always outperformed market averages, until that fateful day.

On October 28th, 1929, I tried to take some profits after Charles Whitney had propped up the prices of US Steel. I was trying to sell 10,000 shares, but my fat finger pressed an extra key twice. My sell order ended up being for 1,290,000 shares. Before I could tell anyone it was an error, everyone panicked and the whole market starting heading down. The next day was the biggest stock market crash ever. In early 1930, I was banned from trading for 85 years.

I went back to Hong Kong to work at my family's goldfish store. Please come and visit us at Phat Goldfish in Kowloon, only a 3 minute walk from the C2 MTR entrance.

I thought everyone would forget about me and planned to quietly return to trading in 2015. To my horror, any error in quantity or price which cause a problem kept getting blamed on Fat Finger, even when it was a mix up and not an extra key being pressed. For example, an error by a seller on the Tokyo Stock Exchange was to sell 610,000 shares at ¥6 instead of 6 shares at ¥610,000. That had nothing to do with me or with how fat the trader's finger was, but everyone kept yelling, "Fat Finger! Fat Finger!" In 2016, people blamed a fat finger for a 6% drop in the GBP. It really was a combination of many things, none to do with me or anyone else who had a wider than average finger.

Now that I can trade again, I'm finding forex more interesting than stocks. I've been doing some research on trading forex and other instruments and I'll be sharing it here.

If you see any typing errors, you can blame those on my fat finmgert. If you see any strange changes in price, it's not my fault.

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