Over the years, many investors have made tons of money investing in the Forex and Stocks market. This has made them very popular investment vehicles that usually generate questions like “Forex vs stocks: Which should you trade?”.
However, because they are quite different from each other, with different strengths and weaknesses, many investors have been left wondering which is the most effective in helping an investor accumulate wealth, especially as a beginner.
This article will be reviewing each in detail, to help you make an informed choice on which vehicle you wish to exploit as you invest.
Let’s get going!
What is Forex?
The term Forex is derived from two words – Foreign and Exchange. Forex simply refers to the trading of one currency for another one. For instance, trading the US dollars for the Euro. Foreign Exchange transactions take place on the Foreign Exchange (Forex) Market.
The Forex market is the largest, and most liquid market in the world, with trillions of dollars in trade every day. The Forex market has no central location. Rather, it is an electronic network of banks, intuitions, brokers, and individual traders.
How does Forex Trading Work?
In Forex, traders simply bet that Central banks will ease or tighten their monetary policy and that one currency will strengthen versus the other.
On the Forex market, currencies are listed in pairs, such as USD/JPY, USD/CAD, EUR/USD, etc. These represent the U.S. dollar (USD) versus the Canadian dollar (CAD), the Euro (EUR) versus the USD and the USD versus the Japanese yen (JPY).
Prices are attached to each pair of currencies. So, if for instance, 1.325 is attached as the price for USD/CAD pair, it means that it costs 1.325 CAD to buy one USD. IF this price increases, it means that the USD has increased in value to the CAD since it now costs more CAD to buy one USD.
The Forex market is open for trade 24 hours a day, five days a week across the major forex markets across the world.
How does trading happen in the Forex Market?
In Foreign Exchange Markets, traders buy or sell any of the currency pairs listed in the market. Although they may be buying foreign currencies, there is no physical exchange of money from one hand to another, as is common when exchanging forex in a bank or Forex kiosk.
Rather, traders here are buying a currency pair, in the hopes that there will be an increase in the value of the currency they are buying, so they can make a profit.
Types of Forex Markets
There are three types of forex markets and they are as follows:
Spot Forex Market
In Spot Forex Market, buying and selling forex is done and completed on the spot, meaning that the exchange happens on the exact spot the trade was completed. In this market, you buy and sell the currency pair at the current market rate, known as the spot price.
The Forward Market
In the forward forex market, trades are settled in a date further than the spot when it was agreed. The price adopted in the forward market is a combination of the spot plus or minus the forward points that represent the interest rate differential between the two currencies.
Majority of the forward market trades have a maturity that is less than a year in the future, even though it could be more distant.
As in the Spot market, prices are agreed on the date of transaction, however, the money is exchanged on the date of maturity.
It is necessary to note that the contract in the forward market is made to suit the need of the parties in the negotiation. It can be fixed at any amount and on any date of their choosing, so long as the date is not a weekend or a holiday in any of the countries involved in the negotiation.
In a future forex market, transactions are settled in a future date, just like in the forward market. However, the difference between both markets lies in the fact that trades done in the Future market are legally binding on both parties involved in the trade.
FAQs in The Forex Market
What is a base and Quote Currency?
A base currency refers to the first currency listed in a forex pair, while the second currency in the pair is the quote currency. For instance, if the listed pair is USD/CAD, USD is the base currency while the Canadian dollar is the quote currency.
Factors That Influence Price Changes in the Forex Market?
The forex market, as you may know, is large, comprising of various central banks, banks, institutions, and currencies from all over the world. Each move any of these institutions makes plays a role in the price fluctuations in the stock market.
The major factors that may influence the fluctuations on the forex market include the following:
- Central bank policies.
- Financial and Political news reports.
- Market/Investor sentiment.
- Economic data.
- A country’s credit ratings.
Each of these and sometimes a combination of these factors influence the fluctuations seen in the forex market.
What is the Stock Market?
Investopedia defines the Stock market as a collection of markets and exchanges where the activities of buying, selling and issuance of the stocks of publicly held companies take place.
These activities happen through institutionalized formal exchanges or over-the-counter trades (OTC).
Stocks are equities that represent fractional ownership of a company, and a stock market is a place where investors can buy and sell ownership of these assets.
The stock market allows companies to access capital quickly for expansion, through the sale of stocks. This, in turn, helps an economy develop rapidly.
How does the Stock Market Work?
As a primary market, the Stock Market allows companies to issue and sell their shares to the public for the first time via a process known as Initial Public Offering (IPO). Through this IPO, companies can raise capital for their projects.
In the process of selling shares via an IPO, a company divides itself into several shares and sells part of these shares to the public.
To implement this process of IPO, a company has to go to the Stock market, because it is the only place where stocks/shares can be sold. If the company is successfully enlisted in the stock market, it could go-ahead to sell its shares.
Apart from enlisting the stocks of new organizations for sale, the stock market also serves as the trading platform for regular buying and selling of already listed shares. This is known as the secondary market.
For every trade completed in the secondary market, a fee is paid to the stock exchange.
As a company listed on the stock market, you can also offer additional shares through other offerings at a later time. You can do this through any of the processes known as Rights Issue or follow-on orders.
You can even choose to buy or delist your shares from the stock market. The Stock Exchange supports such transactions.
The responsibility of the stock exchange includes ensuring price transparency, liquidity, price discovery, and fair dealings in all trading activities.
Since most stock exchange markets operate digitally now, it is the duty of the Stock exchange to maintain trading systems that efficiently manage the buy and sell orders from various market participants.
They are also to perform the price matching function to facilitate trade execution at a price that is fair for both buyers and sellers.
Forex vs Stock: The differences
To understand which to trade, you must first understand the differences between Forex and Stocks. We will be discussing a few in this section under these subheadings:
Forex vs Stocks: Market Trading Hours
The Forex market is open 24 hours a day, 5 working days a week. During this time, all traders can conduct their trading activities. However, this extended trading time means that a lot can happen even when you are not observing the market.
To maintain profitability in Forex as a trader, you must have a strategy that keeps your interests covered when you are not observing the market.
The trading hours are quite different in the Stock Market. It is often limited to the opening hours of a Stock exchange market. However, some major Stock Exchange Markets now offer extended trading hours to traders.
Even with this facility, the trading hours are still several hours short compared to what is available in the Forex Market.
Forex vs Stocks: Market Influences
Another difference between both markets is the factors that influence them. Although both markets are primarily influenced by the market forces of demand and supply, several other factors still influence market prices in these markets.
In the stock market, factors that could influence market prices include the debt levels of the company, its cash flows, and earnings, news report, economic data, etc.
However, in Forex, the influencing factors are far more and complex. In truth, the whole macroeconomic factors of a country can affect the value their currency has on the Forex market.
Factors like the unemployment rate, inflation, gross domestic product (GDP), etc. are all major influences that could tilt the prices on the Forex market.
Forex vs Stocks: Liquidity
Liquidity refers to the ease at which an asset can be bought or sold in a market. This is an important thing to consider when deciding on which to trade between stocks and forex.
The Forex market is an extremely liquid market with millions of traders all over the world buying and selling forex 24 hours a day, 5 days a week.
However, the Stock market is not as liquid as the forex market, since a smaller volume of trading is done here. Although the stocks of blue-chip companies such as Apple, Microsoft, etc. experience a reasonable amount of liquidity, liquidity drops with smaller companies.
If you prefer a market with high liquidity, of course, the Forex market will be ideal for you, and vice versa.
Forex vs Stocks: Volatility
Volatility refers to how likely a market’s price will make major unforeseen fluctuations. A market with high volatility is one in which prices can change almost suddenly, with little or no warning.
One of the hallmarks of the forex market is its high volatility. It is prone to sudden price shifts that for the most part, cannot be predicted. The high volume of trade that happens on the forex market may be responsible for these sudden changes.
On the other hand, the Stock market is quite stable. Volatility can be described as low. Although prices change every now and then, they are often predictable and are influenced by noticeable factors.
The volatility levels of both markets come with their merits and demerits. A high volatility rate can mean that you will make huge profits within a short time. It can also mean that you can lose nearly all your money in a few minutes.
Trading on leverage means to gain exposure to markets with just a fraction of the capital required normally. Leveraged products like CFDs allow traders to trade on margin across a range of markets.
Of course, leverage trading comes with some advantages and possible dangers. It can magnify your gains as well as your losses if you make a mistake. Leverages are generally higher in forex than in the stock market.
Forex vs Stocks: Which should you trade?
We have tried to discuss the Forex and Stock Markets, as well as their differences, to give us a good basis to answer this question.
So, what is the answer?
Truth is, the answer lies in your investment strategy!
If you are a short-term investor who seeks quick profit, and you have a healthy risk tolerance, the Forex market might be ideal for you since it favors traders with these characteristics and strategies.
However, if you are a long-term investor, and have a low-risk tolerance, you are better off trading Stocks, since they are more suited to long-term investors, and have lower volatility.
As the Sophists once said: man is the measure of all things! Meaning a person decides what is good or acceptable with them and what is not.
If after learning these things about both markets, you believe one to be best suited to your needs, then go right ahead and do what you are most comfortable with.
However, ensure to conduct further research on any area that catches your fancy to learn more before you start trading.
Cheers To Your Success!