The object of trading (no matter what type of trading it is) is to make as much money as possible. When looking for assets to trade, it often seems that most traders don’t give much thought to where they’ll have the best opportunity for profit. They don’t adequately evaluate whether stock trading or Forex trading is a better option, they tend to just make a decision randomly, and then pursue it. However, it’s a good idea to think once in a while about whether stock or Forex trading is more suited to your investment style and your financial goals – and perhaps to adjust your trading accordingly.
Why Trade Forex Instead of Stocks?
There are two ways to trade stocks. You can buy or sell actual stocks at a stockbroker, or you can trade CFDs (contracts for difference) based upon underlying stocks which tend to be the option offered by retail Forex and CFD brokers.
If you do not have at least $10,000 to deposit, then it will probably make economic sense to trade stocks using CFDs. However, the total spread plus commission charged on a Forex trade is hugely lower than the equivalent trade in an individual stock CFD. As I researched this topic, I checked the advertised spread at a well-known retail Forex brokerage for EUR/USD and a CFD based upon Glencore PLC, a publicly quoted company on the FTSE 100. The spread for EUR/USD represents about 0.02% of the instrument’s value, while the spread for Glencore represents 0.23% of its value. That is a large difference.
There is also the question of overnight financing at non-Islamic Forex or CFD Brokers. Typically, the interest charged in holding a Forex pair overnight might amount to about 3% of the position’s value if it were held for a period of one year. With stock shares, the interest charged is typically a little higher.
Lastly, it is important to consider that if you hold a CFD based upon a stock you generally will not receive any dividend payments that may be made if you were to take a similar stock position with a stockbroker.
There is no doubt that the costs of trading stock CFDs with retail brokers are significantly higher than the costs involved in trading Forex.
Forex vs. Stocks
It makes sense to trade something where the price is going to fluctuate by a lot. After all, you need the price of something to move significantly in order to make any profit buying and selling it! The easiest way to make money is by trading something where the price goes straight up or straight down, although of course it is rarely as simple as that.
In this respect, stock trading typically offers much better opportunities than major Forex currency pairs, no matter how well you understand Forex trading basics. In attempting to prove this I present a table showing the maximum annual absolute percentage value movements in the EUR/USD currency pair and the world’s greatest stock index, the S&P500 Index:
We can see that over the last decade, on average, the S&P500 Stock Index has moved almost double the range of the EUR/USD pair. Additionally, individual stocks can move much more than its Index will. So it is obvious that much more profit can be made when you trade stocks than in trading Forex, at least on an unleveraged basis.
How much leverage can and should be used is a very important question for retail traders. Let’s start by looking at stock trading, taking the example of the U.S. Securities and Exchange Commission. If you are purchasing real stocks from a licensed broker, your maximum leverage at the end of the day you buy the stock is 2:1. You must put up at least half of the cost. If you are selling stocks short, the rules range from slightly over 3:1 to 1:1 depending upon the price of the stock. You will pay (at the time of this writing) something like an annualized interest rate of 8% on the leverage, meaning that the stock must move by at least 8% in value per year in order for the leverage to be worthwhile.
Of course, retail brokers offering CFDs that are based upon the price of the stock are far more generous with leverage, but generally the leverage they offer in Forex trading is even more generous. Typically, a Forex broker might offer a maximum leverage of 100:1 on Forex currency pairs, but only 20:1 on individual stocks. This means you can potentially profit five times as much on a Forex movement than you can on a stock movement, on a like for like basis.
The Difference Between the Forex and Stock Markets
If you are looking to hold trades for a long time, buying specially-picked stocks in line with the start of a strong bull market is probably the best profit you can get. However, if you can only afford a retail CFD broker, the cost of holding the position for a long time is likely to be considerable, and if you are over-leveraged, any strong adverse movements – which are common in stocks – could be frightening (and costly).
Forex tends to be less volatile, and less manipulated by high-frequency trading algorithms. Due to the lower cost of frequent trading and higher leverage, if you are going to be day-trading, it is arguably easier to day trade Forex than stocks. It should also be considered that there are no “short” positions in Forex, and short positions in stocks can be subject to restrictions. Forex markets are also open 24 hours per day during the week, unlike the stock market, and brokers often shut down their stock markets meaning you are stuck in a position with no effective stop loss overnight every night, if you hold a position that long.
If you have a lot of money, i.e. a large 5-figure amount in U.S. Dollars, and you have a long time horizon, you will probably be able to make maximal profit by buying real stocks through a stockbroker you could find in our stock broker reviews in a strong bull market. At this level, the commission/spread is much more reasonable because it is a fixed dollar amount.
If your account is much smaller and you are looking to trade on shorter time-frames or just to day trade, then you will probably have a better chance trading Forex through a broker you could find in our regulated forex broker reviews. However, if you have done research and really favour a few particular stocks in a bull market, you can probably benefit from short-term holdings of these stocks, but you should be very careful in your total exposure.