Right now, both investors and traders have access to a wide range of financial instruments, such as stocks, securities, and forex, to name a few. In fact, forex and stocks are two of the most popular markets in the world. As technology advances so rapidly that traders can now access these financial markets through a few simple clicks on their mobile phones, it stands to reason that trading is becoming more widespread.
While there are similarities between the two financial instruments, there are essential differences that traders must be aware of. Not knowing the difference between the two can vitally impact one’s trading decisions and bottom line. As such, we explain in detail the main differences between forex and stocks, so read on to find out more.
What are stocks?
First things first –we need to understand the basics of what stocks and forex are. The stock market is the market that most people tend to know of. Essentially, stocks are when you invest in a portion of a company. They represent an ownership of a particular company’s assets and earnings. Stocks are issued to fund the operations of a business and are often traded on stock exchanges. Popular stock exchanges include the New York Stock Exchange (NYSE), and Nasdaq. As such, most stock trades must follow government regulations that are there to protect traders from any fraudulent activities.
What is forex?
On the other hand, forex –which is a portmanteau of the words ‘foreign currency exchange’, is where people buy and sell one currency for another. Currencies are traded on the foreign exchange market, which is one of the largest financial markets in the world. Trades tend to be listed in currency pairs such as EUR/USD. The currency on the left-hand side is typically the base currency, whereas the one on the right is typically the quote currency. Other popular currency pairs include USD/JPY, GBP/USD, AUD/USD, USD/CAD and more. To start trading forex on a forex trading platform, one must first open a brokerage account.
One of the major differences between the two financial instruments is how much leverage it has. Typically, forex trading offers higher leverage when compared to trading stocks – as much as 50:1. This can be advantageous to traders first starting out – especially if they do not many funds – as leverage allows them to gain access to larger trading positions and only pay a fraction of what it is worth upfront (known as the margin). This means they can gain more opportunities when forex trading. On the other hand, if you are trading stocks, you will likely not be able to access the advantages of leverage.
That being said, leverage does come with risk. While it can magnify your trading opportunities, it also amplifies loss. For instance, if you end up making a losing trade, you will have to pay back what the whole trading position is worth, not just your initial small deposit. As such, leverage remains a double-edged sword, especially for novice traders.
In layman’s terms, liquidity is how easily something can be bought or sold in a market. As the forex market is one of the most active and largest in the world, it boasts extremely high liquidity. Since there are so many traders in the market, it is easy to find another trader to take the opposite side of your position. In fact, the forex market sees a daily turnover of trillions of dollars! This also means traders can take advantage of short-term market moves. On the other hand, while there are a few stocks that are liquid (especially if they come from popular conglomerates), large stock purchases can easily influence their price, which can significantly impact a trader’s bottom line. This is not really a problem in forex trading, because, with millions of dollars in the market, trades tend to not influence a currency’s market price.
Another major difference between forex and stock trading is their trading hours. As forex is a completely global market, this means you can trade 24 hours a day, 5 days a week. This allows traders more opportunities to open strategic positions, but it also means they have to constantly monitor their trades in case something drastic happens. Essentially, forex traders have the option of trading in different time zones – such as the Asian, European or US markets — so there is almost no limit to any trading activity. Contrast this with stock trading, where the exchange has set hours. These hours are generally 9:30 am to 4 pm EST, 5 days a week.
While prices in both markets are influenced by supply and demand, there are a few other factors that can also impact prices. When it comes to stock trading, traders need to keep an eye out for how their chosen company is performing. This can include keeping track of their cash flows, earnings, and debt levels. Other things that can influence a stock’s price are economic and current events, in addition to how the industry is doing. With forex, these factors are a lot more complicated. Traders also need to take into account how the country is doing, for instance, its unemployment, GDP, and inflation rates, alongside any current events. Also, because forex is based on the trading of currency pairs, traders will need to be aware of more than one economy’s performance.