This post provides an overview of the forex markets and the stock markets. It compares and contrasts these two markets and suggests which market might be the best fit for a particular trader. And finally, this post highlights how the Morpher trading experience can enhance stock or forex trading strategies.
Multiple types of trading platforms enable investors and traders to execute trades. For example, the forex markets’ fast-paced, highly liquid nature may be appealing to very active traders.
In contrast, for those investors or traders seeking a more long-term, investment-styled environment, the regulated stock markets might be a better option. Whatever the case, there are a number of factors to consider before joining the ranks of forex traders or stock investors.
The foreign exchange market (the currencies market, FX, or forex) is the world’s largest and most liquid financial market. This market had an average daily trading volume of over $7.5 trillion USD in 2022. In comparison, the New York Stock Exchange (NYSE) and the National Association of Securities Dealers Automated Quotations (NASDAQ) have a combined average daily trading volume of around $250 billion. Therefore, on average, the foreign exchange market transacts a mind-boggling 24,000 more daily transactions than the NYSE and NASDAQ combined.
The forex over-the-counter (OTC) market is a decentralized global marketplace where currency trading occurs. Unlike a centralized exchange like the NYSE or the NASDAQ, the forex OTC is not located in one centralized location. Rather, it operates globally, where market participants from anywhere in the world can buy, sell, exchange, and speculate on the relative exchange rates of various currency pairs.
Forex trading involves an exchange of one currency for another currency for both hedging and speculative purposes. Fiat money is the only traded commodity.
Forex trades are represented by what are termed currency pairs. That is, purchasing one currency while simultaneously selling another currency.
A typical currency pair listing may look something like this: EUR/USD 1.5. Here, the euro (EUR) is termed the base currency (also referred to as transaction currency), while the U.S. dollar (USD) is termed the quote currency (also referred to as the counter currency). The ratio between the base currency and the termed currency is referred to as the ratio price, which in this example equates to 1.5. That is, one euro will trade for 1.5 U.S. dollars at this particular point in time.
As the quoted currency value rises or falls relative to the base currency, traders buy or sell currencies to make profits.
The different types of forex markets are described below.
The majority of forex trading occurs in the spot market, where trades take place in real time between buyers and sellers at the current exchange rate. Spot market participants include commercial, investment, and central banks, as well as brokers and speculators.
Forward markets are decentralized and comprise companies, institutions, private individuals, and governments. Forward markets are useful for hedging, where two parties agree to trade a currency at a predetermined price and at a future date.
Because forward markets lack a centralized platform, they may be subject to risk, where one party to the transaction defaults on a pending trade. Such a platform may also suffer from a lack of liquidity since there are only two parties involved in the transaction.
Future markets operate similarly to forward markets. However, unlike decentralized forward markets, future markets rely upon centralized exchanges. Such exchanges reduce the potential for counterparty default while increasing market liquidity.
The stock market provides a platform for investors to buy and sell publicly traded company shares. Investors can also buy and sell other assets, such as bonds, ETFs, and stock indices.
Purchasing a stock represents an investment in a company. Therefore, a stock represents a proportionate ownership stake in a company’s assets and corporate earnings.
Some stocks are publicly traded, while other stocks are privately held. Trades regarding public stocks are executed on regulated exchange platforms like the NYSE and NASDAQ.
Privately held shares are generally not traded on US public markets like the NYSE or NASDAQ, as they are not publicly listed. Instead, private shares are typically bought and sold through private transactions negotiated amongst individuals and financial institutions.
The stock market serves two primary purposes. First, companies can issue shares to the public and receive funds in return, where these funds are used for business purposes. Only stock exchange-listed companies can issue shares to the public.
Second, the stock market provides liquidity for buyers and sellers of the stocks listed on the stock market. In the secondary market of stock exchanges, retail, and institutional investors, buy and sell these listed stocks.
Forex and stock markets operate quite differently. A few of these differences are discussed below.
Stock traders have an overabundance of trading options and opportunities. For example, the NYSE lists almost 2,000 publicly available stocks. And there are 3,300 active stocks listed on the NASDAQ. So, the equity markets provide over 5,300 trading opportunities where investors and traders can concentrate their efforts and perfect their trades.
Compare this to the limited trading opportunities available to forex traders. As already noted, forex traders trade in pairs. And there are only seven (7) primary forex currency pairs to choose from.
Four of these are referred to as the traditional “four majors” which include EUR/USD (euro versus US dollar), USD/JPY (US dollar versus Japanese yen), GBP/USD (British pound sterling versus US dollar), and USD/CHF (US dollar versus Swiss franc). And then, there are the three (3) most-traded “commodity currencies,” which are AUD/USD (Australian dollar versus US dollar), USD/CAD (US dollar versus Canadian dollar), and NZD/USD (New Zealand dollar versus US dollar). These seven major forex currency pairs make up an overwhelming majority of all forex trades.
The stock market and the forex market are two markets that are regulated quite differently.
The stock market, securities brokers and dealers, investment advisors, and mutual funds are intensely regulated by the US Securities and Exchange Commission (SEC). The SEC protects investors and maintains fair and orderly markets while facilitating capital creation.
In contrast, the forex market is regulated by a patchwork of regulatory bodies such as the Commodity Futures Trading Commission (CFTC) and the National Futures Associate (NFA) in the United States, the Financial Conduct Authority (FCA) in the UK, and the Australian Securities and Investments Commission (ASIC) in Australia.
Most active traders would concur that the SEC places a much higher degree of scrutiny on the equity stock markets, thus leading to greater transparency within these markets. For example, listed companies on the stock market must disclose detailed financial information and other important corporate details to the public. In contrast, the forex market operates more opaque fashion, with transactions occurring between banks, financial institutions, and other large institutional investors.
This difference in regulatory scrutiny might be more attractive to certain traders. For example, some traders might be taken aback by such regulatory oversight and favor a more free-flowing trading platform, like the forex markets.
On the flip side, other traders may see market regulation as a positive sign. For traders seeking to trade in a more secure environment, heightened regulation may provide security against potential bad actors and misinformation.
Leverage is commonly used by both stock and forex investors. However, the maximum available leverage level varies significantly between these two markets.
For example, stock leveraging for US-based investors is limited by statute. US-based stock traders must first establish a margin account with a broker who will max out a trader’s leverage at 2:1.
However, intraday traders can seek higher amounts of leverage in accordance with the SEC’s Margin Rules for Day Trading. First, an intraday trader must establish a margin account with a balance greater than $25,000. This $25,000 amount is referred to as a margin.
This enables intraday traders to achieve “pattern day trader” status, thus allowing them to access up to 4:1 leverage. This means that for every $100 in their account, the trader can trade up to a maximum of $400 worth of stock.
Trading with leverage in forex markets can be much more aggressive than in the equity markets. Like leveraged stock traders who must establish a margin account, a forex trader must also open a forex margin account. However, unlike in the equity markets, there are no statutory qualifications for seeking forex leverage. Depending on the geographical location of the lending institution, forex traders can expect to access as much as 100:1 leverage.
Volatility is a trading metric used to gauge short-term price fluctuations. A highly volatile market is one where prices are unpredictable and make wide swings during trading sessions.
Intraday traders rely on volatility to time their market entries and exits, while other buy-and-hold traders – HODLers – rely upon a less volatile and less risky investment environment. As a consequence, the volatile forex markets attract many short-term traders.
In contrast, traders more comfortable with buy-and-hold long-term investment strategies may prefer to trade less volatile assets offered by the equity markets.
Forex currencies are much more volatile than equities in the stock market. One reason for this heightened volatility is that currency values are influenced by not only national considerations but other global issues as well, such as political, social, and economic events.
Another reason for the forex volatility is that these markets operate on a decentralized platform where trading occurs 24 hours, five days a week, throughout various time zones. This platform also does not undergo the same type of regulatory scrutiny as the stock markets. As a result, the forex market can be more susceptible to sudden and unpredictable changes in market sentiment, supply, and demand.
On the other hand, stocks typically follow market cycles. Although these market cycles are somewhat predictable, they can be influenced by national events but less so by global events. Stocks are therefore considered to be less volatile than currencies.
Shares of a publicly traded company are purchased when someone trades a stock at the market price. And this market price is determined by the supply and demand for the stock in the market. This market price will fluctuate based on a number of factors, such as company performance, industry trends, and market sentiment.
The supply and demand of currencies in the forex markets are not premised on such factors. Although the supply of a country’s currency ebbs and flows over time, a large amount of currency is always available to trade.
A forex trade involving several hundred million dollars in a major currency will most likely have little to no impact on the currency’s market price. There is simply too much supply for any such single transaction to have a market impact.
In contrast, purchasing several hundred million dollars worth of publicly available stock may impact the stock’s price. This effect is particularly powerful for smaller corporations with fewer outstanding shares, as opposed to large-cap stocks with high trading volumes.
Currencies are quoted by a pair of currencies – the base currency and the quote currency. These two currencies make up the ratio price.
Forex traders must therefore monitor not only the macro- and microeconomic conditions of the country responsible for the base currency but must also monitor the macro- and microeconomic conditions of the country responsible for the quote currency. Therefore job growth, inflationary pressures, GDP, or political unrest within these countries could affect the overall ratio price.
In contrast, when equity traders purchase a large-cap stock like Procter & Gamble (P&G) (ticker symbol: P&G), they will not be spending their time monitoring how other stock prices move in relation to the P&G price.
Rather, these traders will be focused on whether P&G continues to show continued earnings growth, whether P&G shares will increase in value, or whether P&G will continue to maintain its high dividend yield.
Forex markets can exhibit extreme sensitivity to emerging political and economic events. If there is a fundamental shift in governmental power or an unexpected policy change, this could cause a sharp movement in the exchange rate. This might also lead investors to reduce their risk by seeking a safer haven, one with a more stable currency.
Political events can and do affect the U.S. stock markets. However, such political events will be less intense, given that the stock market is influenced by a number of external factors as well as a company’s underlying business fundamentals. These events and external factors normally tend to play out over longer time horizons.
The forex market practically never sleeps. The market remains open 24 hours a day, every day of the work week, from Monday through Friday. So traders can trade currencies non-stop throughout the workweek.
The equity markets have multiple opening and closing trading sessions during the week. That is, trading sessions begin with the opening bell at 9:30 a.m. and end with the closing bell at 4:00 p.m. EST. Although there is some “after-market” trading, those trading opportunities are less desirable as they can raise certain trading risks.
For example, the SEC has noted various risks that can arise with after-market trading platforms. During extended-hours stock trading, there is generally less trading interest and, therefore less price competition. This lack of liquidity can raise trading costs, increase uncertainty with respect to prevailing prices, or make it more difficult to execute trades.
In addition, investors may find greater price fluctuations than they typically would see during regular trading hours. And, certain existing mechanisms that address volatility in specific stocks or in the market may be limited or unavailable during extended-hours trading.
Deciding whether to be an active forex or stock trader is a personal choice. A choice that is dependent on personality, investment goals, timelines, and risk tolerance. Before jumping into one or the other, individuals should consider the following factors.
Stock markets provide different types of opportunities to buy and sell shares of individual companies. Individual companies can be selected to track a specific industry sector, technology, or index. Owning a share in a corporation provides investors with an opportunity to earn long-term profits through capital appreciation and potential dividend payments. A variety of stock trading strategies can be used, including value investing, growth investing, and momentum investing.
On the other hand, the global forex market provides investors with the opportunity to trade currencies against one another with the goal of profiting from changes in exchange rates. This can be accomplished by way of buying and selling individual currency pairs in a market that does not face the scrutiny of intense regulatory agencies, such as the SEC.
Moreover, forex traders can use volatility to make short-term trades or take advantage of price swings in different currency pairs. Popular short-term forex trading strategies include scalping, day trading, and swing trading.
The forex market also allows investors to trade on massive amounts of leverage, allowing traders to amplify their potential profits but may also substantially increase potential losses as well.
Traders debating between forex and stock trading should also consider transaction costs. Transaction costs in the forex market are generally lower than in the equity market. This is because forex brokers do not charge commissions. Moreover, the difference between the bid and ask price (i.e., the spreads) is also usually tighter.
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The stock and forex markets offer different trading opportunities and can suit investors with different goals and risk tolerance. It is important for an investor to carefully consider their goals and risk tolerance before deciding which market to invest in.
Disclaimer: All investments involve risk, and the past performance of a security, industry, sector, market, financial product, trading strategy, or individual’s trading does not guarantee future results or returns. Investors are fully responsible for any investment decisions they make. Such decisions should be based solely on an evaluation of their financial circumstances, investment objectives, risk tolerance, and liquidity needs. This post does not constitute investment advice.