Main Differences Between Forex and Stocks

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Two of the most popular markets for trading include the stock market and the Forex market. Both of these markets offer excellent opportunities for active investors and traders. There are, however, some major differences between the two that retail traders should be aware of. In this lesson, we will compare and contrast the most important considerations in deciding between trading in the forex market versus trading in the stock market

Forex Market vs Stock Market

Most new investors and traders that get started in the markets typically start off in the stock market. This is in partly due to the general familiarity that investors have with companies and share prices. The stock market is also one that has a long-standing history and gets a lot of news coverage. In fact, buying shares of companies is often considered the patriotic thing to do.

The Forex market, on the other hand, has only seen its popularity rise over the last two decades or so. Before that, it was primarily a venue for big institutions, banks, and hedge funds. There was very little retail activity within the foreign exchange markets prior to that. Because of this, many traders and investors are still somewhat unfamiliar with the inner workings of the currency markets, and how to best participate in it.

Within the stock market, you can either invest in an individual stock or a broad market index, and there is an upward bias seen in stock prices over the long run. For example, the US stock market has averaged a return of approximately 9% a year over the last hundred years or so.

Currencies on the other hand trade as pairs. That is to say that a currency pair trades in relation to another currency. For example, the EURUSD currency pair represents the exchange rate of the Euro versus the exchange rate of the US dollar.

Forex Trading vs Stock Trading

Aside from the pure mechanics of trading in the Forex market compared to the stock market, there are other considerations that a trader must make. These include characteristics such as liquidity, volume, trading hours, transaction costs, volatility, and leverage among other factors.

Additionally, based on your desired trading timeframe, you may find it easier and more efficient to trade currencies versus stocks. We will discuss these various differences particularly as it relates to day traders and the regulatory environment. Moreover, depending on whether you prefer a long only strategy or one that utilizes both a long and short strategy, you may decide on one market over the other.

If these considerations weren’t enough, there is also the important consideration of tax efficiency. We will look at the tax implications of trading stocks versus currencies, from the perspective of the shorter-term trader and longer-term trader. We will be providing insights into all of these points, so that you can answer for yourself the question of whether Forex trading is better than stock trading or vice versa.

Forex Volume Compared To Stock Market Volume

In terms of the sheer size of the markets, the Forex market is much bigger than the equities markets. To give you some perspective on the depth of the foreign exchange market versus the equities markets, it may help to know that the average daily turnover in the Forex currency markets exceeds $4 trillion daily. The NYSE, which is considered the largest stock market exchange in the world transacts less than $200 billion daily.

Another interesting statistic within the Forex market is that the vast majority of the nearly $4 trillion daily volume occurs in less than a half dozen or so major pairs. This includes the EUR/USD, USD/JPY, GBP/USD, USD/CAD, USD/CHF and AUD/USD. Because of the high volume that can be seen within these currency pairs, traders can easily get in and out of positions with minimal cost and slippage. Most stocks, on the other hand, have relatively low volumes to make them efficient trading instruments for anyone except longer term position traders.

Liquidity In Forex vs Equities

Liquidity goes hand-in-hand with volume. That is to say the more volume that is inherent in a particular trading instrument, the more liquid that trading instrument will be. A high level of liquidity refers to the ability to transact in the market efficiently without any significant impact on the price of the trading instrument. A good amount of liquidity also leads to lower bid ask spreads, which will help reduce the overall cost of transacting in the market.

All the major currencies, as noted earlier, and a handful of cross currencies, have excellent liquidity characteristics. Within the US stock market, there are only about 100 stocks or so that offer extremely good liquidity characteristics. This includes stocks such as Apple, Google, Facebook, Bank of America, Tesla, to name a few. The majority of other US listed stocks, over 5000 to be conservative, will have much less desirable liquidity characteristics. And this is especially true when comparing liquidity in most penny stocks to forex pairs.

forex-vs-stocks-ticker-symbolsTrading Hours In Forex vs Stock Market

The trading session within the equities markets is much shorter than those within the spot currency markets. For example, the New York Stock Exchange, NYSE, opens for business every weekday at 9:30 AM Eastern, and closes at 4 PM Eastern. Most other major equities markets around the world also have similar trading hours based on their specific time zone. And so, generally speaking, the vast majority stock trading activity will occur within an eight hour window, five days a week.

The Forex markets on the other hand are a 24 hour market, and one that is open for business five days a week. There are three major trading sessions that make up this 24 hour market. This includes the New York session which opens at 8 AM Eastern and closes at 5 PM Eastern. The Australian market becomes active starting at 5 PM Eastern through 2 AM Eastern.

The Tokyo market takes over the vast majority of Forex transactions starting at about 7 PM Eastern, running through their closing at approximately 4 AM Eastern.

The European session kicks off at 3 PM Eastern as the Frankfurt and London markets get underway. This market session runs until 12 PM Eastern time. And so, as far as trading hours go, the foreign exchange markets offer a much longer window of opportunity for trading throughout the day.

Transaction Costs For Currency Trading vs Stock Trading

There are two primary costs related to executing trades in the market. This includes the bid ask spread and the commission cost. The bid ask spread refers to the differential in the market price to buy versus the market price to sell. The commission cost is composed of any costs paid to your broker or exchange for transacting in the market.

Within the Forex markets, some brokers, called dealing desk brokers will not charge a commission, but rather will make their fees from marking up the bid ask spread. Other Forex brokers, commonly referred to as ECN brokers, will charge a small commission, but will not add a markup to the wholesale spreads. Typically, the ECN forex broker will wind up being more cost-effective in the long run.

Within the equities markets, the vast majority of brokers will charge a commission for executing a trade. These fees vary greatly depending on whether you are utilizing a discount broker or full service broker to execute your trades.

A recent phenomenon in the stock market has been the emergence of zero commission brokers. This includes brokers such as Robinhood, and Webull that do not charge a commission for trading. Rather, these brokers generate their income from the order flow generated.

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Volatility In FX vs Stocks

Volatility is an important concept for traders to understand. It refers to the amplitude of price movements in the market. More specifically, a market that is said to have high volatility will exhibit a wide range in terms of price movements. Alternatively, a market that is said to have low volatility will exhibit a narrow range in terms of price movements.

Extremely high volatility is often a sign of heightened risk in the market, and extremely low volatility makes it impossible to capture gains from price movements. As such a moderate level of volatility is desirable to make profits from speculative activities.

Traditionally, the stock market will experience the highest levels of volatility during market crashes and during other fear-based events. During a bullish market trend, the stock market tends to exhibit fairly low levels of volatility. What this actually means is that the opportunity for the largest amount of gains per unit of time is usually made available during sharp bearish corrections. When the market is moving higher steadily, the volatility in stocks is generally lower, resulting in less opportunities for outsize gains.

The volatility in the foreign exchange markets tends to be higher than the equities market. That is to say that the volatility cycles within the foreign exchange markets tend to be shorter, and as such, you will often find a frequent rotation between periods of low volatility and periods of high volatility.

Day Trading Forex vs Stocks

For those that are interested in day trading, there are some very important considerations that need to be made. This is because day trading the equities market poses some obstacles that are not present when day trading the Forex market.

As per the regulations in the United States, day traders in the equities market need to fund their account with a minimum of $25,000. A trader that executes four or more day trades within five business days is classified as a pattern day trader. And the above minimum deposit rules apply for all traders that are classified as pattern day traders. As such, if you plan on being an active day trader, you will need to fund your account with this required minimum, or consider another venue altogether for your day trading activities.

There are no such regulations as it relates to trading in the currency markets. In fact, you can start day trading in the Forex market for as little as $500 or less. This is because many Forex brokers offer a very low barrier to entry with their minimum deposits. However, when you are trading with a very small account, you will not be able to implement very many risk management strategies. And so, it’s best to start with at least $1000-$2000, so that you are providing yourself with a reasonable chance of success in the FX market.

Leverage In Forex vs Stock Trading

Another attribute that favors currency trading over stock trading is the ability for traders to access a great deal more leverage in FX compared to stocks. As a general rule, in the stock market, most traders can access up to 2 to 1 leverage. For some more experienced traders, they may be able to access up to 4 to 1 leverage within a portfolio margin account.

Within the Forex markets, traders can get access to much more leverage. The actual amount of leverage that is available will depend on the individual trader’s broker and jurisdiction. For example, within the United States, Forex currency traders have the ability to leverage their positions up to 50 to 1, depending on the currency trading instrument.

Most cross currencies and exotic pairs may be limited to a 20 to 1 leverage ratio, while the major currency pairs may get the higher leverage limits up to the 50 to 1. Outside of the United States, the regulations on Forex brokers are much less stringent. As a result, these jurisdictions can allow Forex brokers to extend leverage limits that go well beyond the 50 to 1 limits set within the United States.

Now, although leverage can certainly help amplify returns, it should be noted that it can also amplify losses. As such, traders and investors need to view leverage as a double-edged sword, and use it in a responsible manner.

Tax Considerations For Stocks vs Currency Trading

There are different tax implications for stock traders versus Forex traders. Within the United States, your capital gains tax rate on a stock or ETF will depend on your holding period. More specifically, if you hold a position for one year or longer you will benefit from the reduced longer-term capital gains tax rate. The longer-term capital gains tax rate will vary based on your specific filing status. However, currently that rate is capped at 20% at its upper threshold.

If however, you hold the position for less than one year, your gain will be taxed at your ordinary income tax rate. Your ordinary income tax rate will also vary based on your filing status and the income earned during the specified period. Currently, that rate is capped at 37% at its upper threshold. As you can see, the capital gains tax rate can be substantially higher for shorter-term and intermediate-term stock traders that hold positions for less than one year.

Forex traders enjoy a much better tax structure compared to stock traders. Within the United States, currency trading transactions are classified as 1256 contracts. Within this classification, the tax rate is calculated based on the 60/40 method.

More specifically, the 60/40 tax rate method means that 60% of the capital gain is charged at the long-term capital gain rate, while 40% of the capital gain is charged at the shorter-term capital gain rate. And this classification applies regardless of the holding period. As such, Forex trading is much more tax efficient, particularly for active short-term and intermediate-term traders.

Long/Short Versatility For The Stock Trader vs Forex Trader

Some investors and traders prefer a long only style of trading, while others may take positions both on the long side, and the short side of a market. Depending on your preference, you may be better off trading stocks or Forex. Within the US equities market, there is something called the uptick rule. The uptick rule requires that the price of a stock trade higher before it can be shorted. This makes it very challenging to consistently trade the short side of any stock or ETF.

Adding to this challenge, shorting a stock requires that you borrow the stock from your broker before you can actually short it in the market as an opening order. This, however, is not always feasible, which could further limit your ability to go short.

Forex traders on the other hand are not encumbered by any of these rules. Forex traders, can just as easily go short any currency pair, as they could go long any currency pair. Additionally, there is no uptick rule to contend with.

As such, FX traders can execute sell orders at any time they wish to do so. Because of these characteristics, traders who have long short strategies are much better off implementing those methods in the foreign exchange market.

Market Influences In Forex vs Shares

There are different factors that influence the price of currencies versus stocks. When analyzing a stock, you will want to employ security analysis that includes studying such things as a company’s growth prospects, current valuation, and debt ratios.

In addition to specific data around the company’s metrics, you will also want to analyze its competitors within the sector, and the broad market index as well. Beyond this, stock traders should also utilize some form of technical analysis to help them better time their entries and exits.

Currency traders will focus on more macro fundamental data such as inflation figures, employment reports, retail data, trade surpluses or deficits, GDP, and more. As such, there are many more big picture variables that Forex traders need to be aware of in their decision-making process.

Along with fundamental Forex analysis, they will also need to be skilled at market timing. There are many forms of technical analysis that can help FX traders with market timing. Some of the more popular methodologies include Elliott wave, Fibonacci analysis, and Chart pattern analysis.

Final Thoughts- Is Forex Better Than Stocks?

As we come to the tail end of this article, we pose the question once again. Is it better to trade Forex or stocks? Well, there can be no definitive answer to this question, because it will depend on the personality and goals of each trader. Having said that, the Forex markets tend to offer a better environment for active traders compared to the equities market. This is particularly true traders that reside in the United States.

For those traders that are just starting their journey, the stock market may be a better starting ground. This is because stocks tend to be easier to understand for most people, and the mechanics behind trading in the equities market is fairly straightforward. After traders have gained some experience in the stock market, they can consider getting some exposure to the currency markets. This is generally the best, most logical, course of action for beginning traders.

Obviously, there will be some exceptions to this, and you should use this lesson as a guide to better understanding the pros and cons of each market, and decide on the best course of action for yourself.

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