For securities traders, two popular markets are the stock market and the foreign exchange (forex) market. One of the biggest reasons some traders prefer the forex to the stock market is enhanced leverage capabilities. However, others prefer the regulatory safeguards of the stock market.
Below, we compare the differences between stock trading and forex trading.
What's the Difference Between Forex Trading and Stock Trading?
|Forex Trading||Stock Trading|
|Leverage Limits||50:1 or more||4:1|
|Liquidity||Much larger supply, liquidity||Less supply, liquidity|
|Trade Pairing||Any currency||USD (in the U.S.)|
|Market Hours||24 hours per day, five days per week||Most trading occurs between 9:30 a.m. and 4 p.m. (EST), Monday–Friday|
In stock trading, traders with a margin account may use as much as 2:1 leverage. However, day traders who open and close their positions within a single day and maintain an account balance of more than $25,000 can trade up to 4:1 leverage. There are also some qualifying requirements before you can do this. Not every investor is approved for a margin account, which is what you need to leverage in the stock market.
Forex trading is very different. To qualify to trade with leverage, you open a forex trading account. There are no qualifying requirements. The exact leverage limit depends on the brokerage, but many traders can expect to access as much as 50:1 leverage.
This is just one way in which forex markets are less regulated than stock markets. For some, the limits imposed by regulations may push them toward forex trading. Others see regulation as an extra layer of protection against fraud and wrongdoing, so they may prefer to trade in that environment.
When you trade stocks, you buy shares of companies that cost anywhere from a few dollars to hundreds of dollars. Market price varies with supply and demand. Trading on the forex market is a different world. Although the supply of a country's currency can fluctuate, there is always a large amount of currency available to trade. All major world currencies are highly liquid, which means the two markets have very different price sensitivity to trade activity. Stock purchase of 10,000 shares may impact the stock price. This effect is particularly powerful for smaller corporations with fewer shares outstanding, as opposed to giants like Apple.
In sharp contrast, forex trades of several hundred million dollars in a major currency will most likely have little—or no—impact on the currency's market price. There is too much supply for any single transaction to have too much of an impact.
In currency trading, currencies are always quoted in pairs. Not only do you have to be concerned with the economic health of the country whose currency you are trading, but you also have to consider the economic health of the country against which you are trading. Does one country have more job growth than another, or better GDP, or political prospects?
When you buy Intel shares, your primary concern is whether the stock will increase in value; you're less concerned with the stock prices of other companies. The only "pair" is between the stock price and the U.S. dollar (if you're trading in the U.S.).
Forex markets sometimes exhibit greater sensitivity to emerging political and economic situations in other countries. The U.S. stock market isn't immune to political events, but it is usually less sensitive to geopolitical issues.
Currency markets have greater access than stock markets. Traders can trade stocks nearly 24 hours a day from Monday through Friday, but it isn't particularly easy to access all those of markets.
Most retail stock investors trade through a U.S. brokerage with one major trading period from 9:30 a.m. to 4:00 p.m. EST. There is a much smaller "after-hours" trading market, but those hours typically have less liquidity and other issues that make them less popular than regular trading hours.
Forex trading, on the other hand, is much easier to do around the clock, Monday through Friday. There are many forex trading institutions worldwide, and it's always trading time in one time zone or another.
Which Is Right for You?
Deciding which market to trade is largely a personal choice. Here are some factors to consider.
When Forex Trading Works Best
The comparative freedom from regulation on the forex and its high degree of possible leveraging makes it easy to control large trades. A beginning forex trader has many of the tools available to them that a seasoned trader has, whereas a stock trader needs to acquire special qualifications and save up a significant amount of capital to trade like the pros. If you're eager to start trading large amounts of capital, forex trading is for you.
When Stock Trading Works Best
Stock trading can be easier to wrap your head around. While broader economic context always helps, buying a stock is a simple concept—you're buying a share of ownership in a company. That, along with the highly regulated environment, can put some traders at ease and help them focus on their trading strategy.
Short traders, however, may find that stock trading actually carries more risk, as a result of how currency pairing works. When a stock market declines, you can make money by shorting, but that imposes extra risks.
In forex trading, you can go short on a currency pair as easily as you can go long. The two positions present similar risks. No additional precautionary trades to limit losses are necessary.
One risk of shorting a stock, at least in theory, is that you may have unlimited losses. In reality, that's unlikely to happen because your broker will probably force you to end the short position. Nevertheless, most financial advisors caution against shorting for all, and many of the most experienced investors execute parallel stop-loss and limit orders to contain this risk.
The Bottom Line
Most investors are more familiar with the stock market than with forex, and that familiarity may be comforting. Others will prefer the higher risk/reward ratio that comes with the unregulated forex environment and its high levels of leverage. Whichever you choose, trade carefully and control your risk with stop-losses.
- Forex trading is generally less regulated than stock trading, and forex traders have access to much more leverage than stock traders.
- Forex trading uses pairs, so the trade depends on the performance of two economies rather than trading a single stock.
- Currencies are more liquid than stocks, they trade at all hours of the day, and large orders have less impact on currency pairings than they do on stock prices.
Financial Industry Regulatory Authority. "Day-Trading Margin Requirements: Know the Rules."
Securities and Exchange Commission. "Investor Bulletin: Understanding Margin Accounts."
National Futures Association. "Trading Forex: What Investors Need to Know," Page 13.
Office of Investor Education and Advocacy. "Investor Bulletin: After-Hours Trading."
National Futures Association. "Trading Forex: What Investors Need to Know," Page 7.