Forex vs. Stock Market
The stock market is attracting many traders on the day to day basis as it is characterized by many swings and fluctuations. These swings are the salt and pepper for traders as profits can be made. Exactly such swings are the reason why Forex market is so popular as well. If the market would be characterized by small movements, or mostly ranges, it will be difficult to capitalize on such moves and the trading concept would not be so widely accepted. So far you should have an idea about what is driving the Forex market and what foreign exchange stays for. Some traders are still confused when looking for a market to trade and don’t know what to trade: stocks or Forex. Are these two markets equally risky? Is the approach the same or traders should consider different things when trading them?
Differences Between the Two Markets
There are some notable differences between the two markets and they must be mentioned here. From the brokers that offer the financial products to be traded, all the way to the factors that influence the markets… everything is different. Below there are the main factors that matter when trading both Forex and stocks. Please note that they are not listed based on their relevance, but simply because traders must know the difference between these markets.
The Way to Trade Them
The main difference between the two financial markets comes from the way they are traded. To be more exact, stock market trading has some limitations that are not seen on the Forex market. To start, when trading stocks, it is not possible to sell a stock, unless you already own it. This sounds only normal, but on the Forex market, one can sell a currency pair without owning it. In other words, you can go short EURUSD, for example, on the Forex market, and if the currency pair is moving South, you can bank on that move and make a profit by covering the short (hence closing the position with a long) at lower levels. This is not possible on the stock market. The only way to sell a stock is to own it. This means, you must buy it first, and if it moves against you, you can sell it but in a loss. If it moves up, you can sell it for a profit. But you must own it first, and this makes for different trading strategies to be in place for the stock and Forex market.
Brokers to Trade Them
You may find it difficult to believe, but there are few or little brokers that offer you the possibility to trade both Forex and stocks on the same trading account. Moreover, there is unlikely that a broker will offer both products. Therefore, it is either you trade stocks with a dedicated broker for the stock market, or you don’t trade them at all. It means that to trade both stocks and Forex, you need to have trading accounts with two different entities, or brokerage houses. Margins needed for trading the two markets are different too. While the Forex market is known to be the most leveraged one, on the stock market a cash account is mostly used to cover the expenses when buying stocks. There are, though, stock brokers that offer margin trading as well, but this is not widespread as it is in the case of Forex trading. Moreover, costs are different when trading Forex and stocks, with the last one being more expensive.
Factors that Make the Two Markets Move
Like any financial product, supply and demand are governing the way the product is moving. If there is bigger volume one the long side, the product will move up and the other way around if the volume on the short side is bigger. Both markets are moving based on fundamental and technical factors. Fundamental analysis is news related. This means that when economic news, like unemployment rate, GDP (Gross Domestic Product), interest rates, retail sales, etc., is released, both markets are moving. However, they are not moving the same on fundamental analysis. Technical analysis, on the other hand, is based on interpreted previous patterns that formed back in time with the purpose of forecasting future price levels. No matter the financial product traded, technical analysis is the same. However, here we need to differentiate between two things: trading stocks and trading indices. An index is moving based on the aggregate move of the stocks that are being part of it. For example, the DJIA (Dow Jones Industrial Average) is formed out of thirty companies. Because of that, it is also being called Dow30. The way these thirty stock prices are moving will determine if the Dow Jones will end up higher or lower on any given day. However, the companies represented in the Dow are not having the same weight: some represent 0.5% of the whole index, other 1.7%, and so on. This makes it possible for the Dow to be positive if the heavily weighted companies in the index are green and the other ones red. And the other way around being true as well! There is an index for any stock market in the world, and these indices are being offered by Forex brokers as well, as an individual and separate financial product. Therefore, there’s no need for having a separate trading account to trade indices. However, there is not possible to trade one single stock on an index with a Forex trading account. If your broker says it is possible, think again: what the broker is offering for trading is a CFD (Contract for Difference) and not the real stock. For more about CFD’s, please refer to the article dedicated to that subject here on our Trading Academy – Forex vs. CFDs. As a reminder, CFD’s are one of the most riskier financial assets to be traded, and, as such, require considerable margin in the trading account. There are other factors that are different for the stock market when compared with the Forex one. One of such a factor is the earnings calendar. On a quarterly basis, companies around the world are releasing their earnings, and traders are reacting to these releases by taking a position in a new company or simply closing a previous position. Moreover, in between these quarterly releases, stocks are being rated by analysts. When these ratings are changing to different levels, from buy to neutral or sell, the price of an individual stock is changing. This is not happening on the Forex market, as the dynamics are simply different when compared with the stock market. Keep in mind that everything discussed here about stock and Forex market is only a few things that differentiate the two. They are clearly distinct ones, and one should be aware of that before engaging in trading.
Recommended Further Readings
- Basics of Technical Analysis
– What is technical analysis, why it is important and why traders are using it. Advantages over fundamental analysis are highlighted as well.
- Basics of Fundamental Analysis
– What is fundamental analysis, where to look for information that makes the market moving, advantages and disadvantages of trading based on fundamentals.
- Trend Indicators
– Explaining what trading indicators are, where to find them, and their benefits when trading Forex market based on technical analysis.
– Discussing what oscillators are, what are the differences between an oscillator and a trend indicator, and what are the most representative indicators that fit into this category.
- Central Banks
– What is the role of a central bank in Forex trading, why the market is moving aggressively when monetary policy is set and what information to look for when the central bank is deciding over its policy.
- Technical Analysis – Support and Resistance Areas
– Defining what support and resistance areas are, how to find them using technical analysis and why traders are looking to buy into support and sell into resistance.
Other Educational Materials
- “Returns to buying winners and selling losers: Implications for stock market efficiency.” Jegadeesh, Narasimhan, and Sheridan Titman. The Journal of finance 48,
- The behavior of stock-market prices. Fama, E.F., 1965. The journal of Business, 38(1), pp.34-105.