Forex Trading vs Stock Trading: The Complete Beginner’s Guide
What is the Forex Market?
When a European company wants to buy American products, it needs to exchange its euros for U.S. dollars. And in order for an American firm to import European goods, it must convert its dollars into euros. The vast, global marketplace that allows for these currency conversions to take place is called the foreign exchange market, more commonly known as Forex.
Forex is the world’s largest financial market, with a jaw-dropping $7.5 trillion traded each day. Rather than being centered in one location, Forex is a network of global banks, brokers, and investors. Unlike stock markets, it is open 24 hours a day and five days a week. Currency trading activity in Forex peaks during its three major trading sessions (Asia, Europe, and North America) which all overlap for several hours each day.
Traders buy and sell currency pairs on Forex, speculating on changes to exchange rates. For example, if they believe that the EUR/USD exchange rate will rise (relative to USD/CAD), they can buy the EUR/USD currency pair. The most traded currency pairs in the Forex market are the major pairs (EUR/USD, USD/JPY, GBP/USD, etc.). These pairs have higher liquidity and lower transaction costs.
What is the Stock Market?
The stock market is an exchange where buyers and sellers trade shares of publicly listed companies. Buying a share of a company means that you become a part-owner of that business. Stock markets and their exchanges give the investing public access to trade in shares of all kinds of companies, from blue-chip stalwarts like Apple and Amazon to small- and mid-cap growth stocks.
The combined market capitalization of all publicly traded companies around the world is estimated to be about $100 trillion. Stock markets do not trade 24/5 like Forex does. Instead, they operate only during their official exchange hours.
Differences at a Glance
| Characteristics | Forex Market | Stock Market |
|---|---|---|
| Trading Volume | $7.5+ trillion per day | $200-300 billion per day for US stock markets |
| Trading Hours | 24 hours per day, five days a week | Exchange hours only (limited to working hours) |
| Market | Currency pairs | Shares of individual companies |
| Ownership | No ownership | Part ownership of companies |
| Leverage | High (up to 1:500) | Limited (usually 1:2-1:5) |
| Dividends | No dividend income | Potential for dividend payments |
“Forex Stock”: What does it Mean?
A “Forex stock” is a misnomer that usually is used by beginners. The concept simply does not exist since the terms are being confused:
- Forex is the market for exchanging currencies in the form of currency pairs.
- Stocks are shares of companies that are listed on the stock market.
While no such thing as a “Forex stock” exists, there are Forex brokers that are publicly traded companies such as IG Group or FXCM. These brokers have stock prices on a stock exchange, so their price performance may be of interest to a Forex trader.
Do Stocks and Forex Move Together?
There are two major drivers of the Forex market, the equity markets (stocks) and economic and geopolitical developments. Here is a closer look at how these two influence currencies:
Strong Equity Markets can have a strong influence on the respective local currency. The bullish stock market outlook and prospects for capital appreciation attract foreign money, which fuels demand for the local currency. A weak or falling equity market often results in investors pulling their money out, weakening the local currency. A new development in the financial markets that further complicates this relationship is the widespread trading of exchange-traded funds (ETFs) that track both stock indices and currencies.
Examples
The biggest such example is the interplay between U.S. stocks and the U.S. dollar. A rally in the U.S. stock market attracts international investors to buy U.S. stocks, and they need dollars to make their purchases. As a result, they buy the USD and convert their local currencies into it, which increases demand for the USD. In other words, there is a correlation between the performance of the USD and the US stock market performance, which is visualized as a positive slope (above-zero) correlation coefficient.
Forex Trading Scenarios to illustrate the Equities-Currencies Relationship
- The Bank of Japan injected 10 trillion yen into the economy on July 15, 2006, and began large-scale, ongoing market interventions to weaken the Japanese Yen. Over the next few years, the Yen weakened, and the Nikkei225 index consistently rallied.
- The Bank of Japan was again targeting a weaker Yen with its negative interest rate policy (NIRP) from late 2014. From the end of 2014 to June 2015, the Yen weakened and the Nikkei225 posted large gains.
- During the European debt crisis that started in 2010, stocks in the Euro area were dropping while the Euro currency also weakened.
- Bank of Japan interventions (buying Yen to weaken it) over the last decade have shown that when Yen weakens, the Nikkei225 index typically rallies.
Forex Trading vs Stock Trading: A Comparison
Forex
Forex market’s biggest advantage is liquidity and tight spreads. Traders can open and close large positions with very little slippage.
Stocks
In the case of stocks, liquidity varies from stock to stock. Blue-chip stocks are among the most liquid securities, but penny stocks are notorious for their wide spreads and low volumes.
Forex Market Hours
Forex market trading hours give traders a 24-hour schedule that makes it possible to trade around the clock five days a week.
Stocks: Trading Hours
Stock markets and their respective exchanges typically trade during fixed hours. For example, the US stock markets are open from 9:30 a.m. to 4 p.m. (US Eastern Time). It’s important to note that in global stock markets, traders have to contend with multiple time zones.
Forex Volatility
Major currency pairs typically average 0.5-1% volatility on any given day. During high-impact news events, Forex volatility can shoot up. Another example of additional risk is weekend gaps: Currency prices may open at a big gap up or down on Mondays after the previous week’s market closure.
Stock Volatility
In contrast to Forex, stocks show highly varied volatility. Biotech and tech stocks are usually more volatile than blue chips. On the other hand, stock prices often experience concentrated volatility around earnings announcements. In general, stock markets are less volatile than Forex.
Forex Leverage Reality
Forex brokers usually offer leverage up to 1:500, but this is not set in stone. For retail traders, most Forex brokers offer leverage ratios starting at 1:2 or 1:3, with the maximum leverage being offered to more experienced traders.
Stock Trading Leverage
The stock market is different. Retail stock traders typically have access to 1:2 to 1:5 leverage only. In the US, margin trading is subject to special rules that limit leverage. The maximum allowed leverage for US retail stock traders is 1:2, and a pattern day trading account is required to have at least $25,000 in capital.
Trading in Both Markets
Forex market can be traded 24 hours a day, five days a week. The three major Forex trading sessions are Asian (Tokyo), European (London), and American (New York), with the most significant volatility during their overlapping hours.
Day trading in the stock market means trading in real-time during exchange hours. For the US stock markets, the volume and volatility are the highest during the first and last hours of the trading session.
Analysis Methods
The stock market and Forex market share similar technical analysis indicators and tools. Chart patterns work very similarly for Forex and stocks. All the popular technical analysis indicators such as Moving Averages, Relative Strength Index (RSI), Stochastic, and Moving Average Convergence Divergence (MACD) apply to both markets.
Fundamental analysis is a very different story. Stocks require a deep analysis of individual companies, their financials, management quality, revenue, and earnings prospects. While Forex and stocks share some macroeconomic influences, Forex market participants must follow economic and geopolitical developments around the world.
Risk Management Essentials
A simple and easy to follow position sizing rule is to risk a maximum of 1-2% of trading capital on any given trade. Position size must also be adjusted for volatility, and the correlation of open positions to each other must be considered.
Forex and stocks both use technical stop-losses, such as stops on specific support and resistance levels. Another popular technique is the volatility-based stop-losses that account for market volatility, such as Average True Range (ATR) indicators.
Trading Profits: Fact vs Fantasy
Success in either market depends on an understanding of the market’s fundamentals, technical analysis, risk management, and trading psychology. The most important thing is to start with an education that helps you develop a strategy that is suitable for your personality.
Both stock and Forex market success depend on understanding the fundamental forces that drive these markets and your emotions. Develop good risk management and execution discipline. Develop a strategy that is compatible with your trading psychology and personality.
What: Most new traders and investors will lose money.
Reality: This includes even the most professional traders. The average successful pro trader will make between 10-20% a year on their capital. This may not sound like much, but it’s many times higher than the stock market’s S&P 500 index returns.
Psychology: Common Mistakes
- Overtrading to fill the boredom or because of emotional response to losses.
- Revenge trading to make up for losses or mistakes.
- Trading on FOMO (“Fear Of Missing Out”) after seeing big moves develop in a market.
- Accepting that trading is a human endeavor, and losses are just part of the game.
Beginner’s Guide
Ask yourself some questions such as what are you aiming for with your trading/investing, what is your personality like and how much time do you have to trade. (hint: 24/5 Forex is a plus in this category).
Study the basics of terminology, fundamental and technical analysis and start recognizing price patterns.
Forex: Regulatory protection, spreads, commissions and platform are all critical. Stocks: Same as Forex, but also consider additional factors such as broker research and educational tools.
Practice, practice, practice. Pretend your demo account is real money. Learn how to manage your risk, develop execution discipline and master your strategies.
Small is beautiful. Start with small capital and small positions. Keep detailed records of every trade/investment and regularly review your trading performance. A trading journal is a useful discipline to help you stay accountable to your rules and your execution.
Choosing a Market
- Personality, schedule, interests and goals indicate a clear preference for Forex
- Comfortable with high leverage, volatility and its risks
- Enjoy speculating on shorter time-frames
- Like to analyze macroeconomic developments, geopolitical events and economic data releases
- Prefer technical analysis
- Suitability, personality and goals match stock market/investing
- Long-term investors willing to hold positions for months and years
- Prefer stock picking or ETF investing
- Prefer fundamental analysis
Some of the most successful traders trade both Forex and stocks. Common strategies include using Forex for short-term opportunities and stocks for long-term investing and wealth building, diversifying across different markets and time-frames, and balancing your risk profile with a combination of Forex and stocks.
Conclusion: So Which Market Should You Choose?
In summary, both Forex and the stock market have their advantages, and the choice really depends on your goals, personality, and available time. Here is a quick recap to help you decide which market may suit you better.
- You are looking for a market that is accessible 24/5
- You want higher liquidity and leverage
- You are comfortable with short-term trading on lower time-frames
- You like to trade with technical analysis and analyzing macroeconomic data releases
- You are looking to get started with small amounts of capital
- You are interested in long-term investing with a longer-term time-frame
- You want to own part of companies as part of your investment strategy
- You value having the potential for dividend income
- You like analyzing individual companies
- You are willing to wait for the price action to make significant moves
Remember that there is no right or wrong choice, as there is no better market, only a market that is better for you.
There are plenty of traders and investors who trade both the Forex market and the stock market. This can be part of a diversified trading/investment strategy that balances your risk and exposure across asset classes. In either case, the key to being a successful trader/investor in any market is a good education and discipline in risk management and execution.
For traders seeking a reliable partner with proven execution quality, XM stands out as a top-tier choice suitable for both beginners and seasoned professionals.