How To Decide If Forex Or Stocks Is The Best Fit For You
If you have decided to dabble with trading, or even take a leap into the unknown and aim to make your living as a trader, you might have been weighing up the pros and cons of forex trading versus stocks. This is a decision that requires careful thought, and there are many factors that will influence your decision.
Forex trading involves buying and selling currency pairs on the foreign exchange market with the aim of making a profit. When you buy one currency, you simultaneously sell the other. Traders analyse market trends and price patterns in order to anticipate which way the markets are going to move, and to help them to identify the optimum time to buy or sell.
Just 20 years ago, forex trading was the preserve of financial institutions and full-time city traders. Now the markets have opened up into the world’s largest financial exchange with a trade volume of about $5bn per day, and they are highly active almost round the clock. Anyone can access them online via a broker platform.
Stock market trading allows traders to buy small shares of blue-chip companies, such as Microsoft or Apple, or many thousands of others. If the company performs well, the value of the shares increases, enabling you to sell them at a profit. Conversely, if the company performance declines, the value of shares drops.
Here’s an overview of the key differences between the forex market and the stock market, and how to decide which style of trading might suit you best.
Market access
One of the major draws of the forex market is that it offers almost 24/7 access, with peak trading hours that conveniently coincide with the hours just before and after a typical 9-5 day. This means that you can trade at a time that is convenient to you, and it is very possible to fit forex trading around a full-time job.
This is an ideal way to gain experience and build up confidence without the pressure to instantly make consistent profits. Forex trading is a skill that takes time and patience to acquire, and newcomers need to be well-prepared with technical knowledge and armed with psychological resilience (more on this topic later).
Therefore, the flexibility of the forex markets, with 24 hour access to the overlapping London, New York, Tokyo, and Sydney markets, offer new traders the opportunity to trade in a market with high liquidity at almost any time. This means that even if you have just a small window of time to invest, it’s still possible to get a foot in the door.
On the other hand, the stock markets operate strictly on fixed trading hours on a centralised exchange, usually between 8am and 4pm. They are also closed at the weekend and during public holidays, so there is much less flexibility in the hours you can trade. If you have a full time job, this can be very limiting.
Leverage opportunities
The forex markets offer much higher leverage opportunities than the stock markets. This is the use of borrowed capital to invest in a currency or stock, and it can be borrowed from a broker. Typically, a stock market broker will offer leverage ratios of 2:1, whereas forex brokers tend to offer much higher leverage ratios of 50:1 or even 100:1.
This gives you the chance to significantly amplify your potential profits. For example, if you have £1,000 invested in your account, you can access instant forex funding to use a 100:1 leverage ratio to open a position. This would mean that you can control a position of £100,000 in the forex market.
If the value of your currency pair increases by just 1 per cent, then the value of your position rises to £101,000. If you decide to sell your investment at this point, you would make a profit of £1,000, minus any broker fees. Without leverage, your investment would have yielded a profit of just £10; hardly worth the time and effort put into making the trade.
However, the potential for higher rewards comes with the downsides of higher risks. If the value of your currency pair falls by 1 per cent, then you would be £1,000 out of pocket, effectively wiping out your initial investment. Therefore, if you are considering trying your hand at forex trading, you need to be fully aware of the risks.
The key to successful forex trading is a solid risk management strategy and a good understanding of how the forex market works.
Market volatility
Volatility in the markets refers to short-term price fluctuations. This can bring the potential for keen traders to make significant profits, but it also carries the risk of heavy losses.
The forex markets are considered to be more volatile than the stock markets, because they are more susceptible to the influence of geopolitical and global economic events such as elections, inflation rates, and international trade. Stock markets are more dependent on the performance of individual companies, and therefore tend to be more stable.
Therefore, people who relish the challenge of short-term trading are more likely to be suited to forex trading. Blue-chip shareholders tend to adopt more long-term strategies, and this may minimise risk, but it does not offer the same potential for making a steady and profitable income.
Skilled forex traders can supplement their monthly income very comfortably without having to give up their main occupation, whereas stock trading is generally considered to be a more advanced method of investing capital rather than actively generating a steady income.
Points to consider if you think forex trading is right for you
If the opportunities afforded by high liquidity, flexible trading hours, and high leverage appeal to you, then forex trading may be the right choice. However, it’s important to be aware of the psychology of trading before you plunge in. This applies to both forex and stock trading, but the aforementioned benefits of forex also make it more high risk.
Underprepared traders can be taken by surprise when they are under pressure to make fast decisions that will have significant financial consequences. Money provokes strong emotions in even the most stoical of people, and not many of us are truly indifferent to the amount we have. This is because it is so fundamental to our survival and mental and physical comfort.
Therefore, you need to have confidence in the risks you are taking and avoid being tempted by greed for bigger profits, or too crippled by the fear and anxiety of making a loss. Only invest what you can afford to lose, and when considering leverage, it’s best to trade with just one or two per cent of your account value at first.
Use stop losses on all of your trades, which allows you to set a limit on the amount you can lose, protecting you from catastrophic losses.
Never risk losing an amount of money that would compromise your ability to pay for life’s essentials, such as rent, bills, and food, or this would lead to a very slippery slope indeed. Amateur traders who make a stinging loss can be provoked into making further rash trades in the hope of recouping their losses.
This can be a natural reaction through panic, fear, shame, or a sense of entitlement. However, successful forex trading relies on being able to make unbiased decisions based on cold facts and market analysis. It’s about risk management, and you should never make decisions in the heat of the moment.
Many forex traders practise meditation or deliberately focus on a good work-life balance to keep themselves emotionally stable and grounded. This helps them to step back from a difficult situation and reflect before they act.
Of course, it’s impossible to fully protect yourself from losses, and it happens to the most experienced traders, but the key is to find a balanced strategy that will bring consistent profits over time.
Tips for learning about forex trading
Forex trading is undoubtedly demanding, and it takes plenty of effort, commitment and patience to succeed.
It is a broad and sometimes complex field, but the majority of traders concentrate on the seven major currencies of the US dollar (USD), the Great British Pound (GBP) the Euro (EUR), the Canadian dollar (CAD), the Japanese yen (JPY), the Swiss franc (CHF), and the Australian dollar (AUD).
This helps to narrow down the focus, particularly when you are starting out. There are of course many more world currencies, which are referred to as minor currencies and exotics. However, these tend to be more volatile and challenging to trade than the majors, so beginners are advised to avoid them until they gain more experience and confidence.
There is a vast range of resources available to anyone who wishes to learn more about forex trading, and much of the information is free to access online. There are also many books, podcasts, webinars, and online courses available, so it’s easy to find a method that suits your learning style, schedule, and budget.