Recently forex trading has gained increasing attention from stock traders. Why is this?   What benefits does forex trading offer over stock trading for the average trader? To find out , we need to compare the two markets, and how the differences affect traders.

Market size

Compared to the stock market, the forex market is significantly larger. The forex market turns over $1.5 trillion US dollars per day. This turnover offers enormous liquidity compared to the stock market.  This means that you can readily enter or exit your position at close to the market price – no unpleasant surprises as with some thinly traded stocks where you can wait around trying to close your position.

Limited instruments

While there are thousands of stocks, and hundreds of even quite large stocks, there is a limited number of major currencies.  Generally the 8 major pairs account for most forex trading activity.

Forex is more focussed on timing and market action rather than selection of a currency pair.  Stock trading has the additional element of selecting the stock.

Since the currency pairs represent the entire economy of a nation and a huge volume is traded, manipulation of long term direction is virtually impossible with currency trading.  There are no insiders, and the depth of the market means that individuals cannot significantly move the market.

Leverage

The forex market is inherently leveraged. Generally even an individual can trade a one million dollar forex position, multiplying trading capital by over 100 times, while the stock market is essentially limited to what you put in yourself.  It is quite difficult to leverage stock investments significantly – you might be able to prudently borrow 50% of an investment on margin.

This huge leverage multiplies returns (and losses) in forex compared to stock trading.

Global reach, highly liquid

As a global 24 hour market, the forex market offers plenty of buyers and sellers at any time, day or night.  As discussed above, if you need to liquidate your position, you can generally do so in seconds, at close to the quoted market price.

The stock market does not provide this advantage to its traders. With a very limited number of participants, nationally based, and with limited trading hours, sometimes you will find it hard to buy or sell stocks. Some stocks can be very illiquid.  Generally holding periods are longer with stocks.

Go long or short

Stocks are usually bought rather than short sold. When short selling is permitted, there are often restrictions (as we have recently seen in the major stock markets). This restricts profitable trading opportunities during bear markets.

In contrast, a forex trader can go short (sell first, then buy later) as easily as he can go long (buy, then sell later). This allows profitable trading in both up and down markets. In forex, there are always profitable trading opportunities no matter which way the market is moving.

Trading costs

Forex trading transaction costs are far lower than for stock trading. An individual forex trader pays a maximum of $5 to trade a $100,000 currency position and the cost is even lower for larger investors. There are no stamp duty or exchange costs.

For stock traders, brokerage as a proportion of the value of the trade is far higher and there are fees to the exchange and other charges like stamp duty. Stock exchanges also charge for access to their price information. Price information is usually far cheaper for forex trading as this data does not belong to an exchange.

The low trading costs mean that it is feasible to hold forex positions for a short period of time, sometimes only hours.  It is difficult to do with stocks as trading costs quickly consume any profits.

Accessibility

The forex market is open 5 days a week, 24 hours a day. You can trade at virtually any time.  This means that you can do a day job and trade forex in the evening.

Unlike forex, the stock market has fixed opening and closing times which restrict trading opportunities, especially if you work.  The forex market is decentralised, so is not subject to the whims of government.  There are no forced closures.

In summary, forex offers many advantages over stocks, including low costs, liquidity, huge leverage, and ability to trade long or short.

Tags: forex, stock trading

This entry was posted on Sunday, November 15th, 2009 at 6:01 pm and is filed under Forex Basics. You can follow any responses to this entry through the RSS 2.0 feed. You can skip to the end and leave a response. Pinging is currently not allowed.