Forex versus stocks: How do these two trading instruments compare?
Whether you are still learning the ropes or actually understand quite a lot about trading, it is really important to have a clear mind when it comes to getting to grips with the mechanics of your trades.
The financial markets can often seem overwhelming to a first-timer, so it’s important to educate yourself about the different trading instruments. If you read the right content and watch useful webinars – and by the way we have lots of material on demand to guide you right here at FOREX.com – then you can become much more confident about trading.
This article will look at some of the comparisons between forex - otherwise known as currency trading, the foreign exchange market or sometimes simply FX – and stocks, the shares into which ownership of a particular corporation is divided and which are also tradable instruments.
What’s the difference between forex and stocks?
There are many differences between trading currencies and stocks – but also a number of similarities, particularly if we include trading stocks through CFDs, an option for Canadian citizens with FOREX.com accounts.
When trading forex, each trade you make will focus on a single currency pair. It may be EUR/USD, USD/JPY, USD/CAD or AUD/USD – these are some of the more popular pairs. Alternatively, you might be interested in trading the Swiss franc, the Chinese renminbi or the Hong Kong dollar against the US dollar or other currencies.
FOREX.com offers more than 80 currency pairs. When making a trade you will always be either BUYING or SELLING the first named currency in the quoted currency pair. A trader who buys euros in the EUR/USD market believes the euro is set to perform better relative to the dollar; a trader who sells in this market believes the opposite will be the case.
As for stocks, the traditional way to take an interest was to buy equity in any company whose share price you felt had the scope to rise, before selling it at some point in the future (with the intention of securing a profit). Investing in stocks in this way was seen as a long-term play to make more use of savings capital, though it came with the potential for downside in the event of an ill-timed economic crash.
But for retail traders in jurisdictions including Canada there is a different way to trade stocks: they can do it via CFDs (contracts for difference) with FOREX.com.
CFDs: Trading stocks without prior ownership
When buying equity in the traditional sense you must first buy shares before you can sell them. With CFDs, it’s different; a trader who forecasts that a company’s stock is headed downwards can get involved immediately in “shorting” the stock without prior ownership of it. If they think it will rise, they can “go long” or buy into the market.
A CFD does not require someone to physically buy or sell a company’s stock or a particular commodity. It is a transaction in which two parties agree to exchange money on the basis of the change in value of the underlying asset.
The first trade creates an open position, which is later closed out through a reverse trade at a different price. If the trader has correctly judged the market direction between the two trades, they will lock in a profit.
Forex: High liquidity can mean easy access and narrow spreads
With its high liquidity, volatility and 24-hour-a-day trading opportunities during market hours, forex offers traders plenty of scope to buy or sell within individual currency pairs, and without requiring access to derivatives.
Due to the sheer scale of the FX market, with several trillion dollars traded every day, high liquidity is one of the most consistently appealing factors.
Usually when liquidity is high, you have what is termed a “tight” market and spreads – the difference between the buy and sell prices - are low: this is a good thing for all traders but particularly short-term traders. Market liquidity can fluctuate throughout the day as different sessions open and close around the world and it varies greatly depending on the FX pair.
When it comes to equities, some will typically trade more actively than others. The most liquid stocks are usually identifiable by their average daily volume, which can be in the millions, or even hundreds of millions, of shares. Remember, with CFDs, you are not trading those shares per se; you are trading in a synthetic market that closely mirrors the underlying market.
CFDs are designed for short-term share trading and have significant advantages over normal dealing, most importantly the ability to trade on margin and the ability to go short.
Trading 24/5: The forex markets are ALWAYS moving
If you are trading equity CFDs then you are beholden to conduct your business within the hours of the relevant stock exchange on which each company is listed. For example, the New York Stock Exchange operates a core trading session between 9.30am and 4pm Eastern Time.
However, increasingly extended hours are being offered to traders through relevant derivative markets.
One major benefit of including forex within your strategy is its customer-friendly round-the-clock nature. They’re open as regularly as hypermarkets, from 5pm ET on Sunday (9am Monday in Sydney, Australia) until 5pm ET on Friday (when the market closes in New York).
While this is good news for many traders who want to see markets moving at times convenient to them, it is also a good idea to manage your positions by setting “Take Profit” and “Stop Loss” orders, especially when you are offline to protect your trades from unnecessary losses.
Leverage: The ability to trade deeper within a market
At FOREX.com, whether you are trading forex or equity CFDs, we provide leverage to allow traders deeper access to markets. In essence, we are lending you capital to help multiply your buying power in a market and, once you are aware of the risk factors involved, it is an extremely valuable aspect to forex trading. However, traders should be aware that increasing leverage increases risk.
Leverage is normally expressed as a ratio. For example, if your account has a leverage of 20:1, you have the ability to trade a position of $20,000 with only $1,000 of your own funds. In order to maintain your position while trading on leverage, a small amount of money, described as “margin”, is also drawn from your account.
Leverage facilitates efficient trading. However, it is essential traders maintain the minimum margin requirements for all open positions in order to avoid any unexpected liquidation of trading positions.
Whichever market you choose, it is important to be aware of the size of your exposure and understand the risks involved.
To help you understand margin requirements across all our trading instruments available to Canadians, please see this page.
You will see that minimum margin requirements (MMRs) vary widely and that forex pairs typically have much small MMRs than stocks. For example the AUD/CAD pair requires 3% margin, which would provide leverage of 33.3:1 (divide 100 by 3 to calculate the leverage).
But with equity CFDs, MMR tends to be either 30% or 50%. That means if you want to trade CFDs you need to have up to 50% of the value of your initial deposited in a margin account. Leverage is 3.33:1 for equity CFDs that have a 30% MMR and 2:1 for those that have a 50% MMR.
The mechanics: Understanding the basics of forex
If you’re not sure whether forex or equity CFDs suit your trading style better, maybe you could consider opening a risk-free demo account at FOREX.com. This is strongly advised for first-time traders and gives you a feel for how the markets move, and also how margin and leverage works.
You have the option of adding “Take Profit” and “Stop Loss” orders on all active positions that allow you to manage your exposure to the market. And you can do all this without committing a cent of your own money. You may even discover some of our additional CFD products, in commodities and indices.
If you feel you need to learn more about how trading works, our user-friendly educational materials are always on hand. Once you feel confident, you can then open and fund account in just minutes.
At FOREX.com, our intention is to give you all the information you need to help you become a better traders. Read our daily analysis on the markets to get a strong grasp of potential price movements, access trading forums on social media and do everything you can to unravel the ins and outs of forex.
Both Forex and CFD trading involves significant risk of loss and is not suitable for all traders.