What is the difference between forex and the stock market?
The largest difference between forex and the stock market is, of course, what you are trading. Forex, or foreign exchange, is a marketplace for the buying and selling of currencies, while the stock market deals in shares – the units of ownership in a company. Primarily, your decision about whether to trade currencies or stocks should be based on which asset you are interested in trading, but there are some other factors you need to consider.
Market trading hours
The opening hours of a market can have a significant influence over your trading, impacting the time you will need to spend monitoring the markets.
As forex is a completely global market, you can trade 24 hours a day, five days a week. This provides you with ample opportunities for trading, but also creates the risk of the market moving while you aren’t around to monitor it. If you decide to trade forex, it is important to create a risk management strategy with appropriate stops and limits to protect your trades from unnecessary losses.
The best time of day to trade forex is when the market is the most active, which is usually when two sessions overlap, as there will be a higher number of buyers and sellers. For example, if you were interested in GBP/USD, London and New York trading hours overlap between 12pm to 4pm (London time). The increased liquidity will speed up transactions and even lower the cost of spreads.
Share trading is slightly different, as it is often limited to the opening hours of whichever exchange the shares are listed on. Increasingly extended hours are being offered to traders, which means you can act quickly on breaking news, even when the market is closed.
Market influences
Another factor to consider before trading forex or shares is what moves market prices. Primarily, both markets are influenced by supply and demand, but there are a host of other factors that can move prices.
When share trading, you will need to focus on a few factors that directly impact your chosen company – including the company’s debt levels, cash flows and earnings – as well as economic data, news reports and sector health.
But with forex, the focus tends to be far wider, as a more complex range of factors can impact market pricing. You generally need to take the macroeconomics of the country into consideration – for example, unemployment, inflation and gross domestic product (GDP), as well as news and political events. And because you are buying one currency while selling another, you need to be aware of the performance of not just one economy, but two.
Liquidity
Liquidity is the ease at which an asset can be bought or sold in a market. It is an important consideration because the higher the volume of traders, the more money there is flowing through the market at any time – making it easier for you to find someone to take the other side of your position.
Market liquidity can fluctuate throughout the day as different sessions open and close around the world, but it also varies greatly depending on which FX pair you choose to trade. Just eight currency pairs account for the majority of trading volume – for example, the dollar is involved in almost 75% of all forex trades according to the Bank of International Settlements (2016). However, the majority of forex liquidity and trade volume comes from institutional traders.
The stock market sees comparatively fewer trades per day, but shares are still easy to access and trade. Large, popular stocks – such as Apple, Microsoft or Facebook – are the most liquid as there are usually willing buyers and sellers, but once you move away from blue chips there is often significantly less liquidity.
Volatility
Volatility is a measure of how likely it is that a market’s price will make major, unforeseen price fluctuations. A market with high volatility will see its prices change quickly, whereas markets with low volatility tend to have more gradual price changes.
The ease at which forex can be traded makes it extremely volatile. Though the market will usually trade within a small range, the vast number of trades taking place on the forex market can cause prices to change extremely quickly. When trading forex it is important to keep up to date with political, economic and social events, as the market is prone to sudden and drastic movements in response to these announcements.
The stock market tends to have more stable price patterns that you can track over time. But, like forex, it can see periods of volatility and is especially sensitive to domestic politics. For example, the Dow Jones fell sharply in March 2018 as American companies suffered from US President Donald Trump’s trade tensions with China.
Trading volatility can potentially provide a lot of opportunities for traders to profit, but it also comes with increased risk, making it important to take steps to prevent unnecessary loss.
Leverage
Trading on leverage enables you to gain exposure to markets with just a fraction of the capital normally required. Leveraged products, such as spot forex, can be used to trade on margin across a range of markets.
Though it can be an advantage of both stock trading and forex trading alike, it is more commonly cited as a feature of currency trading. Forex trades usually have a much larger leverage ratio, as much as 50:1 in the US. But leverage is a double-edged sword: though it can magnify returns, it can also magnify losses.
Whichever market you choose, it is important to be aware of the size of your exposure, and understand the risks involved.
Going long or short
When deciding between forex and the stock market, it is important to identify all the opportunities available to you – notably, can you short sell? The ability to short a market opens you up to a whole new dimension of market movements, enabling you to speculate on both rising and falling markets.
As forex trading involves buying one currency and selling another, traders have always been able to access falling markets.
When investing in shares, you could traditionally only take a long position, as you’d be looking to profit from any future increase in the value of a company’s stock.
Find out how to short sell
Should you trade forex or stocks?
When it comes to deciding whether you should trade forex or stocks, there is no definitive answer because there are benefits and drawbacks to each market. Ultimately, your decision will come down to your personal preferences and attitude toward risk.
When making your decision, you need take into consideration your trading style and financial goals. If you are interested in a fast-paced environment, forex provides ample opportunities for short-term traders – such as day traders, scalp traders or swing traders. If you’re looking to take advantage of short to mid-term trends, or less volatility, the stock market could be for you.
Trading both forex and stocks can be considered diversification, whereby traders have positions in relatively uncorrelated markets that do not tend to move in the same direction; this can help to reduce large swings in your portfolio's P/L.
*IG US does not offer stock share trading
