When it comes to investing or speculating, probably one of the first questions that comes to mind is whether to invest in stocks or to invest/speculation in the currency markets also known as spot forex. So, what is the difference between trading stocks and forex?
Both of these financial instruments are vastly different and come with difference risk levels. While there are stock traders who also invest in forex and vice-versa, for the new comer, the decision of whether to invest in stocks or in forex can be quite daunting.
Falling prey to some of the myths can easily make a new investor to potentially lose their invested capital. Make no mistake, stocks and forex for that matter are both risky and the investor or speculator can potentially lose all of their invested capital.
While the risks remain the same, if you look a bit deeper you can find that stocks and forex markets are quite different. Although the broad underlying principles remain the same; which is that the buyer and the seller that are involved in trading the prices of stocks and forex which are quite different.
1. Exchange v/s OTC
The stock markets are traded at a stock exchange. One of the most well known examples can be trading stocks at an exchange such as the New York Stock Exchange (NYSE). Trading at an exchange come with certain benefits. For one, traders and investors get access to the order-books which keeps a record of the buying and the selling.
This can be particularly useful for traders or investors who follow either technical or fundamental analysis. Trading at an exchange is considered to be a lot safer.
Looking to the forex markets, trading is done over-the-counter. Unlike the stock markets, there is no centralized exchange for the forex markets. The transactions are done privately between the buyer and the seller.
Such transactions bring with it the risk of a counterparty default.
2. Cost of entry
Trading stocks usually requires a much bigger capital than what you would need to trade forex. Therefore, for most average investors or speculators, forex looks like the easier way to enter into the financial markets.
While it might seem easy, forex trading makes use of leverage, which is required in order for small speculators to magnify their controlling units when trading forex. This is both advantageous and disadvantageous for the speculators.
While profits can be large, losses can also be equally large to the point that they could potentially wipe out the invested capital.
3. Spot forex trading involves buying one currency and selling the other simultaneously
A major difference between stock and forex markets is the fact that when you trade forex, you are simultaneously buying one currency and selling the other. This is different from how stocks are traded. You either buy the shares in the stock or you sell the shares in the stock.
With forex, currency pairs form the instrument. Speculation is done when you expect one currency to rise or fall against the other currency. With stocks, you buy the shares when you think that the share price of the stock will rise.
4. Lower spreads on forex
Spreads, the difference between the bid and ask price are on average smaller compared to stocks. Although some large cap stocks such as Apple have tight spreads, it is not the case with many other stocks that you can trade.
In the forex markets, the major currencies involving the EUR, USD, GBP, JPY, CHF and CAD come with tight spreads due to the volumes that these currency pairs enjoy. Thus in the longer term, the spreads are a lot cheaper compared to trading stocks.
5. Speculation vs. investing
While there are some who speculate on stocks, speculating in the forex markets is a lot cheaper. This is due to the large liquidity pool that is available. In fact most of the retail traders are often speculators holding positions for a few hours or a day at best.
With stocks, it is also possible to speculate but the costs can run pretty high besides the fact that you need significant capital to speculate in the stock markets. Most investors prefer to use the stock market as an investment. On the other hand, the forex markets are a lot more ideal for speculating.
If you are still asking the question of whether to trade forex or stocks, the answer comes from what your risk tolerance is. Furthermore, you should also understand what your goals are whether you want to speculate or invest in stocks or in forex.