Difference Between Forex And Stocks

Difference Between Forex And Stocks

When people think of Stocks they may think of companies and when people think of Forex they may think of currency exchange. These are markedly different both in terms of form (what these market are) and function (what they do). However to some extent traded markets have underlying similarities. This article will look at these different markets and try and see how different they really are.

Stocks and Forex can share this similarity: that they can be traded as CFDs in some regions. CFDs are Contract for Difference, which allow the CFD provider and the client to exchange the difference between the value of the start of the trade to its end. As such, the trader does not own Stocks or Forex. Stocks are also traded as assets, where the trader owns the Stock when they buy it. However, to some extent Stocks CFDs are the norm, espcially at Forex brokers. CFDs allow the trader to trade with leverage and to go long or short. Forex can also be traded in effect as an asset (this used to be the norm), but typically Forex brokers offers CFDs.

Aside from this, Stocks and Forex have significant differences and some similarities. A Stock is or respresents a share in a company and is traded on centralised Stock market exchanges (of which there are many). Forex is traded as Forex pairs, which are one currency valued against another. Behind Forex pairs is the Forex market. This is an enormous market, dwarfing the Stock markets, where the primary traders are banks and institutions. These major players buy and sell large orders for a wide range of reasons, from speculation to currency exchange.

In this sense Forex is not a centralised exchange and ordinary day traders are provided with a way into this market at their providers. The Forex market is the market in which currency exchange takes place, akin to the way a Stock market has a primary function to raise capital for a company, however speculation is also a core driver of changes in value, as it is for the the Stock markets, where brokers or providers offer a way to trade it.

Those who are trading real Stocks or Stocks CFDs or Forex on leverage can be seen as speculators, who seek to amplify changes in value. The changes in the Forex market are relatively small. For example, there may be little speculative incentive to hold a currency for anticipated changes in valuation against another currency (which would be like buying and holding a real Stock). However investors hold Stocks in anticipation of medium and long term gains.

So why not hold a currency ? This does happen, for example companies hedging exposure, however it mostly does not happen on the smaller speculative scale because Forex pairs, unlike Stocks are relative valuations, and to some extent competing. This means that they do not tend to have a preferred direction. Even if they are boosted for example by larger interest rate changes in one currency versus another currency, this can come undone when the other central bank decides to intervene to alter the (relative) weakening or strenghtening of their currency. Even if there is a longer term trends, these can be characterised by steep retracements in the opposite direction.

As the changes in value of a currency are relatively small, traders tend to choose to leverage their Forex instruments. Even where leverage has been restricted, Forex tends to have some of the highest leverage (up to ). Where there are no or less restrictions, significantly higher leverage can be offered. Increasing leverage increases risk and exposure to those retracements. The Stock market can have a 'preferred' direction, in some sense. This is because of the underlying company. It can grow and its valuation based on growth metrics can produce longer term changes in value upwards.

However even so, this can also come undone in a Bear market or an emerging Bear market, where sentiment pulls Stocks down irrespective of their growth metrics and projected future valuations. Even in a Bull market, Stocks can be pulled down for a wide range of reasons, including that they do not live up to their projections. This allows for buy and hold, as well as trading. So unlike Stocks, Forex can be seen, by its nature a trading market. Stocks can be a traded market as well, with leverage or other approaches to amplifying changes in value. However Forex and trading go hand in hand.

When analysing a Stock, traders can take note of the underlying company and analyse it according to varying approaches, for example examining the balance sheet. Forex can be treated this way as well, as the underlying is a country and countries have economies which can be examined and analysed. This is the basis of Forex fundamental analysis.

Forex and Stocks markets have major differences but there are some factors they may have in common

However the effect of economic factors can be hard to gauge. This is a core part of Forex trading, typically trading on news releases, which actively seeks to tackle the complexity of fundamental analysis by tying down the time factor, to the time of the release and the economic data ('news') to one release (this can and does result in unpredictable outcomes as Forex is a complex market).

News trading is also important for Stocks, as are changes in economic data, in terms of the effect these might have on the broader market. However as a trading market there are many influences on the Forex market which can change directions in value. So traders can look for an approach which does not concern itself with trying to untangle dynamic entangled economic influences, rather looks solely at the chart. This is the basis of technical analysis.

Technical analysis is itself mostly based on indicators, which are derived formulae from trading patterns which have appeared again and again over time, as well as rules based on patterns. However many of these indicators and rules were actually developed for the Stock market and are also used extensively there. Why would an investing market want to use technical analysis ? Even if the trader is holding for the medium or long term, they may wish to use analysis, including technical analysis to find a basis to enter, to add onto or to reduce a position or when to exit. This cycle is repeated again and again on a day trading time frame, but can also be applied to longer term positions.

Stocks are open during the opening hours of their Stock market (with caveats about after hours trading), however as a distributed market, Forex can be day traded around the clock, while it is open, that is to say from Sunday to Friday. This said, Forex also divides into market sessions within a 24 hour period. Different Forex pairs may see more liquidity and price action during their 'home' market session (for example JPY pairs in the run up to, during and around the close of the Asian Session).

So when looked into, it can be seen that Forex and Stocks have similarities, when considered as day traded markets. However they differ when viewed as markets for medium and longer term positions. In all events, markets are complex and hard to trade, no matter what apporoach is taken to tackle their complexity and unpredictability.