One of the biggest reasons some traders prefer the forex to the stock market is forex leverage. Below, we compare the differences between stock trading and forex trading.
- 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, as opposed to 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.
In stock trading, traders with a margin account use as much as 2:1 leverage. However, day traders who open and close their positions within a single day can trade up to 4:1 leverage if they have an account balance of more than $25,000. 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. In the United States, you're limited to 50:1 leverage, but in other countries, you can leverage as much as 400:1.
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 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. In consequence, all major world currencies are highly liquid.
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 also with the economic health of the country against which you are trading.
Your fundamental concerns also differ from one market to another. 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. When you're buying or selling on the forex, on the other hand, you have to consider the economics of two countries. Does one country have more job growth than another, or better GDP, or political prospects? A successful single trade on the forex, therefore, requires analyzing two financial entities, not one. Forex markets sometimes exhibit greater sensitivity to emerging political and economic situations in other countries; the U.S. stock market isn't immune but is usually less sensitive to such foreign issues.
Price Sensitivity to Trade Activity
The two markets have very different price sensitivity to trade activity. Stock purchase of 10,000 shares may impact the stock price, particularly for smaller corporations with fewer shares outstanding than, for instance, 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.
Currency markets have greater access than stock markets. Although in the 21st century, it's possible to trade stocks 24 hours a day, five days a week, it's not particularly easy. Most retail investors trade through a U.S. brokerage with one major trading period daily, from 9:30 a.m. to 4:00 p.m., with a much smaller "after hours" trading market with known volatility and price issues that discourage many retail investors from using it. Forex trading, on the other hand, can be done six days a week, 24 hours a day, because there are many forex exchanges worldwide—it's always trading time in one time zone or another.
No Bear Markets in Forex Trading
When a stock market declines, you can make money by shorting, but this imposes additional risks, one of which is that (at least in theory) you may have unlimited losses. In reality, that's unlikely to happen. At some point, your broker will 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.
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.
Greater Freedom From Regulation
Stock trading on major exchanges has many regulations and limits; forex trading is less regulated. In some ways, the regulatory environment of the major stock exchanges imposes limits you may not welcome; it also protects you and other investors to a degree the forex does not.
It's Your Choice
Most investors are more familiar with the stock market than with forex, and that familiarity may be comforting. The comparative freedom from regulation on the forex and its high degree of possible leveraging makes it easy to control large trades without special qualifications and a limited amount of money. That's the upside of the forex market, and the downside—participation in the forex increases both investment opportunities and risk.