In the broadest sense possible, the stock market refers to the collection of markets and exchanges wherein publicly held companies issue and trade stocks, equities and bonds. The trades are performed either through formal exchanges, or over the counter marketplaces. The stock market is one of the most important component of a free-market economy because it works two ways – it gives investors a slice of the ownership in exchange for capital, and is a great opportunity for regular people to try commodities and invest their hard-earned money in something potentially fruitful.
The foreign exchange market is an international, decentralized market that deals with everything related to currency trading – buying, selling and exchanging at predetermined rates. Even though there are some (methodological) similarities between them, at their core they are two wholly different beasts. Let us take a look at how these two markets differ.
Both the stock market and forex market follow a particular schedule. The forex market operates 24 hours a day, with three break sessions during the year. The stock market usually operates between seven and eight hours, in three trading session. This includes the pre-market opening, during which traders can place orders before the market trading session starts.
So, from a time standpoint, one could argue that the forex market is much more accessible because it does not operate after a strict schedule. On the other hand, the around the clock schedule brings a larger volume of people – which is a both positive and negative aspect, as we will discuss below.
The Forex Market is More Concentrated
While various worldwide stock exchanges list hundreds of huge companies with shares that are very liquid, the forex has only three major currencies where most of the action takes place: EUR/USD, USD/JPY, GBP/USD, with USD/CAD, AUD/USD, USD/CHY also being very important.
Spreads (meaning the difference between buy and sell prices) are also very narrow, meaning there is more bang for the buck for day traders because the transaction costs are lower. However, traders do not need to stick to these pairs – also called The Big Eight.
The low amount of currency pairs means that traders can specialize on one niche or another. In fact, long term trade opportunities usually form around more exotic currencies, such as the NZD, SGD and SEK.
Another significant difference between the stocks market and the forex market is the leverage. In the case of forex, brokers accept higher leverages – not as high as before, though – which comes, of course, both with advantages and disadvantages.
The major downside of high leverage is that forex traders must pay more attention to risk management than stock traders, as traders can lose a lot more money than the initial deposit. On the other hand, the eight major currencies experience less volatility than stocks.
Because the margins are higher, forex favors shorter term trading styles, such as the aforementioned day trading or what experts call ‘’scalping’’. However, there are tons of technical analysis tools that can be used for long-term trading.
These tools use principles and methodologies derived from the moving averages and Bollinger Bands, as well as chart patterns and RSI, to spot past and future market patterns and trends. However (yes, there is a downside to everything), due to the high leverage, traders have to exhibit tighter money management and pick entry points with precision, otherwise a lot of money can be lost in the process.
Forex is (Usually) Cheaper
Forex trading is cheaper than stocks due to the thinner spreads, which makes for lower transaction costs overall. Furthermore, brokers do not usually charge commissions for forex trades, as that is retracted from the spread itself. Another reason for the low costs is the intense competition between forex platforms which, in order to survive, have lowered the spreads considerably. This is especially beneficial for day and even casual traders who might not be willing to involve themselves full time into forex trading.
Forex Traders Do Not Need Much Capital
Even though forex traders suffer the disadvantage of having much higher leverages, this factor, coupled with the lower transaction costs, means that profitability is highly possible with less capital than it is required for stocks. Another advantage that most people do not consider is that, unlike the stock market, the shorter time frames makes fundamental analysis methods less important than technical analysis.
Forex Is Much Faster
Unlike the stock market, which is based mainly on bonds and securities, the forex market has a superior liquidity, mainly due to its decentralized nature and how the trades themselves are done. In forex, money changes hands much more frequently.
Furthermore, due to the fact that forex trading is done over the counter – through a broker. This means that trades are executed almost instantly, without any delay. Whereas in the case of stock market trading, investors have to wait for the order to get initiated due to the protection mechanism behind it (this is not to say forex is unsafe or prone to corruption, of course).
With all the similarities the forex market and the stock market have, these are two different beasts with their own sets of advantages and disadvantages. Some of the most notable differences are related to the schedule – the stock market runs between eight and nine hours, while forex is around the clock –, different leverage ratios – forex traders have to pay much more attention to risk management -, and the high liquidity of the forex market. Regardless of these factors, nobody can say if one is objectively superior to the other one, so it is up to investors to choose which one is best suited for their trading styles.