Forex vs. stocks: What’s “better” to trade?
As of 2013, the daily trading volume in foreign exchange was more than $5 TRILLION a day. EWI’s currencies expert, Jim Martens, discusses the pros and cons of trading forex vs. trading stocks.
Who is Jim Martens?
Jim is one of the very few forex Elliott wave instructors in the world, and a long-time editor of EWI’s forex-focused Currency Pro Service. A sought-after speaker, Jim has been successfully applying Elliott since the mid-1980s, including two years at the George Soros-affiliated hedge fund, Nexus Capital, Ltd.
Vadim Pokhlebkin: Jim, many readers of elliottwave.com tell us that they want to make money trading the markets. Would-be speculators have lots of options. Your area is forex — the market which has been growning by leaps and bounds. Can you explain why I’d want to look at forex and not, say, the more “traditional” stock trading?
Jim Martens: A few reasons are immediately obvious.
1. Liquidity. Currency markets are much larger than equity markets. By most estimates, the daily volume in forex is as much as 10 times larger than the combined volume of ALL of the world’s stock markets. That makes it a very liquid market.
2. 24-hour-a-day trading. We are also talking about a market that trades around the clock. That means that if you are a short-term trader and the price spikes after hours, you can adjust your existing position or enter a new one without having to wait until the market reopens the next morning. Sometimes you can do that with stocks too, but typically the spreads (the bid/ask) in stocks after hours widen out, so you may have to pay extra to buy a stock that, for example, announced great earnings after the close of the stock exchange at 4 PM.
That’s not the case with forex. Liquidity stays plenty deep for most investors around the clock. Yes, there are moments when currencies are less liquid, but for most participants, liquidity is fine even then. Spreads stay tight, too — for example, for the euro-dollar exchange rate, or EUR/USD, they are typically 2 pips (points) or less, and they may go to 3 pips when liquidity is not as high. But rarely do we ever see a major widening in spreads.
3. Manageable number of trading choices. I think the ease of choosing a currency to trade is also a big advantage. How many stocks now trade around the world? Between the U.S., European and Asian stock markets, there are at least 40 industries, each with a number of sub-industries, and each one of those with 100+ stocks. So we’re talking about tens of thousands of stocks — and you have to choose the right one! Even in bull markets, while “the rising tide lifts all boats,” as the saying goes, it may not lift your particular “boat” — in fact, your stock may even decline if it’s not the best stock in its peer group, or if you’re in the wrong sector. Often, you see your sector or stock fall even as the general market rises, so you have to be very good — or lucky — at your stock picks.
The currency market has far fewer choices, and it’s a good thing, because that makes your job much easier. Most forex traders stick to the major pairs; in fact, the bulk of trading is between the U.S. dollar and euro — by some estimates, up to 70% of the total daily volume. Besides EUR/USD, we have 5 or 6 other major pairs — and by watching those, you are basically watching the entire world. In EWI’s Currency Pro Service, we track and forecast 11 most popular forex pairs, plus the U.S. Dollar Index.
Of course, you could expand your forex trading into cross rates — those are non-U.S.-dollar currency pairs, like EUR/GBP, for example. But even then we’re still talking about maybe two dozen most active markets versus tens of thousands of stocks. So currencies are just easier to follow in that regard.
4. Limited impact of financial news. Here is another advantage of trading forex. When you trade individual stocks, financial news plays a much bigger role: sector news, individual stock news like earnings, etc. With currencies, we focus on “the big story” instead. There are big economic data releases coming out of each country every week, but we watch economic data calendars and know when they are coming out — and they rarely surprise us. Instead, we spend more time watching forex markets’ technical indicators like Elliott wave patterns, momentum like RSI or MACD, Fibonacci price targets, and so on.
5. Easy long, easy short. Forex offers you the flexibility to go long and short with ease — something that stocks just don’t. When the broad stock market declines, most people are uncomfortable selling short — that is, selling a stock they don’t own in hopes of buying it back later, returning it at a lower price and capturing the spread. Most investors just don’t do that, even with some new avenues for doing so that became open in recent years: mutual funds, ETFs, etc.
In forex, it’s a whole different story. Whenever we quote a currency market — take EUR/USD, again — we are comparing one currency against the other; we are tracking the value of the euro against the value of the dollar. So even when we are selling one market, we are always buying another! We are always buying the base currency, which is the first one in name of the pair. In EUR/USD, the base currency is the euro. On the other hand, in dollar-Swiss franc (or USD/CHF) we track the value of the dollar relative to franc; the dollar is the base.
6. Volatility and trend-following. Forex markets have lots of volatility, too — good for aggressive traders. And if you’re a macro-trader, currencies are well-known for staying with the trend for a long time, too. Volatile at times, yes, but steadily trending.
So, there are several reasons why one might look at forex versus stocks.