Forex and stocks are both financial assets that can be traded. Both have a separate market of their own. If you're looking to become a trader then you need to know about forex and stocks and then you can decide which one should you actually start trading.
What is forex?
Forex is short for foreign exchange. Foreign exchange is the exchange of foreign currency. Foreign exchange takes place due to several reasons, business, investing, speculative, tourism.
The forex market is a decentralized over-the-counter marketplace for the trading of foreign currency or forex.
The forex market is not situated at a physical central location but is traded over the Electronic Communications Network (ECNs) which is an interbank network.
Traders that want to trade the forex have to do so through a broker that provides them access to the forex network.
What are Stocks?
Stocks are basically shares of companies that are listed on stock exchanges. A person holding a stock of a company has some ownership in the company.
The extent of ownership depends on the number of stocks or shares a person owns.
Stocks are traded on the stock exchanges. Each country has its own stock exchange. It is compulsory for a country to have only one stock exchange, several countries have more than one stock exchange functioning.
The stock exchanges are set up by the law of the country and it is governed also by the same. Laws are passed in order to ensure that the stock exchanges function in a free and fair manner.
Violations of these laws can lead to fines or imprisonment or both.
Differences between the two
Since the forex market and the stock markets are two distinct markets for two distinct asset classes, there are bound to be certain differences between the two.
Volumes indicate the total number of transactions that take place in the market. It indicates the number of times the asset has changed hands between buyers and sellers.
The forex market is the sole market for the trading of the currency pairs of countries all over the world, experiences a huge number of volumes generated by the transactions taking place.
The fact that the forex markets are open throughout the day also attributes to the high volumes generated.
The stock markets can never compete with the forex market in terms of volumes generated. This is due to two reasons, the stock markets do not function throughout the day, and that the attention it gets is very limited.
The high volume generated in the forex market makes it the market with the highest daily turnover with $ 6 Trillion worth of transactions taking place daily.
Liquidity is the ease by which an asset can be purchased or sold without causing great fluctuation in its price i.e. without disturbing its price stability.
Liquidity is high when there many individuals participating in the market and are placing orders to buy or to sell the particular asset. Low liquidity is a result of less participation hence fewer orders placed.
The forex market is the sole market for foreign currency. Individuals from every country participate in this market and look to capitalize on the price movements in the currencies.
The attention that the forex market gets is huge enough to generate high liquidity. There are participants looking to buy or sell various currencies at various prices. Higher liquidity leads to lower spreads.
The stock markets do not get the attention that the forex market gets, hence the liquidity in the stock market is way less than the forex market.
The stock market is often looked upon as an investment avenue by the domestic institutional participants as well as the foreign investors.
The amount of attention that the forex market gets and the various happenings in countries all over the world that affect currency prices are the reasons for the high volatility in the forex markets.
Currency prices in the forex market are never dull, there is always an impulsive movement taking place in the price. Only in the rarest situations volatility will be low in the forex market.
Since the primary drivers of the stock markets are the performance of the companies and the country as a whole, the volatility of the stock markets is lesser than that of the forex market.
At any given moment there will be only a few stocks that have impulsive price movements in the stock markets, but these moves do not happen all the time.
4. Narrow and wide focus
There are various currencies of the various countries listed on the forex market but only a few are the majorly traded currencies.
These currencies get the most attention from traders as these currencies belong to major countries that have a good hold in the global scenario.
There are thousands of companies that are listed on the stock exchanges in each country. These companies raise capital by offering stocks to the public.
These stocks are then traded on the stock market. There are many such companies that keep going public.
Since the forex markets consist of fewer currencies that are actively traded, they have a very narrow focus whereas the sheer number of stocks available on the stock market for individuals to trade leads to a wide focus of the stock market.
5. Market manipulation
The forex market is a mammoth of a market owing to the daily turnover of $ 6 Trillion + that takes place in the forex market daily.
This makes it impossible for a single individual or an organization to manipulate the prices of currencies on the forex market and control the same.
Whereas the stock market can be manipulated by big players. There are individuals that have enough money to control the prices of stocks listed on the stock exchanges.
6. Trading hours
The forex market is open 24 hours a day for five days a week and is closed for trading on weekends.
Traders that look to trade the forex can access the market at any time during the day.
The forex market functions throughout the day due to the varying time zones in which forex market participants are situated.
The stock markets do not function for the entire day. Each country’s stock market has its own trading hours during which investors and traders can place trades.
Stock exchanges are also open for trading five days a week. Not all stock exchanges are closed on Saturday and Sunday, for example, stock exchanges in Dubai are closed on Friday and Saturday.
Leverage is basically a line of credit or a loan given by brokers to their clients, which they can use to trade. This would allow traders to have less capital in their accounts and trade big positions.
The leverage that brokers provide to traders in the two markets varies by huge margins.
The brokers in the forex market provide leverage of 1:500 to their clients. This means that the forex traders can enter into positions that would cost 500 times of their capital.
The brokers in the stock markets do not provide such levels of leverages.
Since the stock markets are governed by the laws of the country, countries have laws in place that restrict brokers from providing huge leverages to clients in order to reduce the systematic risks associated with it that can have negative effects on the stock market.
It should be noted that leverage is often referred to as a double-edged sword. If it is not managed properly then it will lead to losses that will wipe out entire trading capital in a jiffy.
8. Market influences
Both the forex market and the stock markets are primarily influenced by the principles of supply and demand. Both markets are traded based on the prevailing sentiment and psychology.
But the supply and demand in the two markets are influenced by different factors.
The stock market is influenced by the performance of the company, reports released by the government of the country, elections results, and by some major global news or report.
The forex market is influenced by the functioning of the countries whose currencies are listed on the forex market.
Information like trade deficits, fed policies, GDP reports, and all the reports and releases that have global macro effects.
9. Transaction costs
Brokers on the forex market charge a small amount as fees from their clients. This is not the case in the stock markets.
The brokers in the stock markets charge a higher fee from their clients.
The transaction costs in the stock markets also include charges levied by the stock exchange and some taxes are levied too.
Hence, traders end up a higher amount as transaction costs in the stock markets as compared to the amount the forex traders pay.
Which one is better?
I cannot give out a decision saying one is better than the other. That was not even the intent of this blog post. This blog post was solely to list the nuances of both the forex and stocks.
The best person to decide if forex is better or stocks, is you yourself. I have been trading the forex market because when I was starting out I decided that forex was better for me.
The same might not apply to another person.
It is very important for traders that are starting out on their trading journey to explore the different types of markets that are out there.
You must compare the pros and cons of each market and then make a decision on your own as to which market should you begin trading in.
Every trader has a different personality, a different approach to the markets, no two traders will follow the same trading plan, and hence it is futile to allow another individual to take the decision.
Traders can always try out different strategies or methods in different markets and decide which one they should stick with.
These days there are brokers or third-party applications that allow clients to virtually trade in the particular market without risking any capital. This is known as paper trading.
I would suggest that every budding trader go through this and get some ground-level experience in different markets and then formulate a trading plan while focusing on one market and mastering it.
Do you trade forex or stocks?
What asset class do you trade, do let me know. Also, did this blog post make it easier for you to make a choice?
If you already trade, what kind of strategies do you use?
Share this blog post with others and let them also understand the difference between forex and stocks.
Reach out to me through the comments section below for any questions and I will get back to it at the earliest.