Traders have tens of thousands of instruments from numerous asset classes available to them to trade, which offers flexibility to earn money from financial markets. Two of the most-traded asset classes are Forex and Indices, with good reason.
I will explain what trading these assets means and note the key differences between Forex and Indices, explaining how to trade them, and looking at the pros and cons. It will help you decide which asset suits your trading style best.
What is Forex Trading?
Forex trading, conducted in pairs, refers to buying and selling currencies, basically where traders exchange one currency for another. For example, going long (buying) the EUR/USD means a trader believes that the value of the Euro, the base currency, (or the currency on which the action is performed), will rise in value versus the US Dollar, the quote currency. A Forex trade is two transactions, buying one currency and selling another, in this example buying euros and selling dollar.
The Forex market is the most liquid financial market, has daily trading volumes exceeding $7.5 trillion, is on track to reach $10.0 trillion this decade, and dwarfs all other financial markets combined. The Forex market is decentralized and operates 24/5. The spot Forex market is where the bulk of trading occurs. Forward and futures contracts also exist, primarily used by governments, companies, banks, and other institutional traders for hedging, while most market participants including retail traders and investment firms deal in the spot market.
What is Index Trading?
Indices trading, the plural of Index trading, is an alternative way to trade equities. Unlike individual stock trading, indices bundle companies into an index, which creates diversification and decreases risk. For example, the S&P 500 consists of the 500 largest US companies. Rather than picking which company will rise or fall in value, the index assigns a collective value on price action for all underlying assets, allowing traders to buy and sell exposure to the market trends via the index in one transaction.
Indices are derivatives, and traders never take physical ownership of the shares within the index. The value of indices is the collective market capitalization of its constituents and the aggregate share price. Most indices use a free-float market capitalization-weighted methodology, where the company size in terms of capital influences its impact on the index. Some are equal-weighted, assigning each index constituent the same value. Many Forex traders use indices to diversify or hedge their portfolios via market and sector indices.
What are the Differences Between Trading Forex and Trading Indices?
Traders should understand the differences between Forex and indices trading. The top five are:
1. Forex trading is a trade on a relationship between two currencies, where the value of one currency moves against another. Indices trading focuses on the underlying value of all constituents in the index, offering broader diversification and less overall risk comparatively. Another difference is Forex trading is a trade that’s value is driven by the economy of the issuing central bank, your risk as a trader is against the country devaluing its currency. Indices trading is a trade on the companies in the index and their collective value propositions.
2. The maximum Forex leverage available in the retail CFD market is 1:500, sometimes more for major currency pairs. Some jurisdictions, like Japan at 1:10, Singapore at 1:20, the EEA, the UK, and Australia at 1:30, and the US and Canada at 1:50, have more restrictive leverage conditions. Maximum indices leverage is usually 1:100, less than Forex but notably higher than other markets.
3. The Forex market is the most liquid financial market. Traders have no difficulty finding buyers or sellers for their transactions in this market. Indices liquidity cannot compete but usually is enough for uninterrupted trade flows, especially at the smaller sizes retail traders need, as most brokers only offer the most liquid indices anyway.
4. The Forex market moves on news and sentiment of economics, monetary, and political developments. Forex traders often trade between one country and its policies against another. Indices also react to macroeconomic events. Rather than focusing on one index component, traders must consider the overall market sentiment, including the specific sectors, if the index bundles together an entire market, like the S&P 500 or the STOXX 600.
5. The Forex market operates 24/5, while equity markets have opening and closing hours, but brokers offering Indices trading often feature 20/5 trading by using futures on Indices.
Indices tend to trend higher over the long term, but currency pairs move freely against each other with no bias in direction.
For example, the S&P 500 like most global Index’s shows an uptrend over 25+ years, while the GBP/USD moved lower over 25+ years.
How to Trade Forex versus Indices
A Forex trading strategy may not work on indices, and vice versa, and traders trading both assets approach them differently. Beginners should master one before managing a multi-asset portfolio with a mix of various trading strategies.
Things to consider for Forex trading:
- 80% of the market is accounted for by algorithmic trading.
- Forex is ideal for ultra-short-term strategies like scalpers.
- Many Forex traders trade the M1 to M15 charts.
- Overlap sessions of major Forex centers account for the bulk of trading volumes.
Things to consider for indices trading:
- Indices are suitable for medium-term momentum and trend following strategies.
- Many traders identify trends using H4 or D1 charts, and entry and exit points on M15 to M30 charts.
- The first and the last hour of each equity trading session typically feature the most trading activity in the day.
- Ideal for hedging and diversifying portfolios
What are the Pros and Cons of Forex versus Indices?
Knowing the pros and cons of Forex versus indices can help traders decide which asset suits their preferences.
Among the pros of Forex versus indices are:
Lower capital requirements
Among the cons of Forex versus Indices are:
80%+ is algorithmic trading
Fewer asset choices
70%+ of the trades are USD, EUR, and JPY
The choice between Forex versus Indices depends on individual preference. Forex tends to cater more to ultra-short-term and short-term traders versus a medium-term approach for Indices.
Forex versus Indices, which one is better?
No asset class is inherently better or worse than another. The answer depends on what traders are trying to achieve and personal preference.
Forex versus indices, which one is easier to trade?
It depends on the skill set of the individual trader, while beginners will face a similar learning curve for either asset class.