For any new investor, there’s one fundamental early decision to make: should you trade forex, or should you trade stocks. Foreign currency markets, or forex markets, are the largest and most liquid traded markets in the world, processing trillions of dollars per day in transactional volumes. Everyone from banks to corporates to holiday makers need to buy and sell currencies daily, with exchange rates fluctuating by the second to reflect the flows of volumes through respective currency pairs.

By contrast, stock trading sees hundreds of billions per day in capital flow through listed companies, who sell and trade shares to raise funds from the markets. When companies perform well or represent an attractive future investment proposition, the value of their shares on the secondary market increases – when their fortunes turn south, the value of these shares decreases.

For traders, profit lies in the gap between the buy and sell over the duration of the position – the wider the gap, the better the return, whether its in currency or in equities. Both types of trading have the capacity to deliver significant returns for those who do their research and make smart moves.

But which is better, and which should you turn to as a trader looking to maximise your returns?

Key Differences: Forex vs Stock Trading

  • Leverage: Those engaging in the stock markets will do so on the basis of a 1:1 investment ratio, this is in stark contrast to forex which can provide up to 500:1 leverage.

  • Research: There are tens of thousands of shares you can trade, there are dozens of international markets to consider. On the other hand the scope of the research involved is much narrower with forex trading than with stocks.

  • Barriers to Entry: the high degrees of leverage in forex trading mean its possible to buy moderate amounts of currency with a very small capital while trading shares will require more trading capital.

An Introduction to Forex

Forex trading is a fast-paced, high-risk environment, where fortunes can be made and lost in the blink of an eye. Traders engaging in forex positions need to know why they’re buying and when they want to sell, to make certain they are in an informed place for maximum value.

As compared to stock trading, the risk profile in forex is substantially elevated – in particular as a result of leverage. Leverage is akin to short-term borrowing, a way of inflating the size of a market position beyond the capital exposed to that position. Traders essentially cover the margin, a percentage of the total transaction size, as the price of investing much more heavily in their chosen position. In forex markets, leverage typically runs at 50:1 or greater, meaning traders can benefit from positions 50+ times larger than the capital they are exposing to the market.

Consider a forex trader with $10,000 to invest in USD/EUR. With 50:1 leverage, they can take a $500,000 position in USD for $10,000 down. A 1% rise in the market for USD would see the position worth $505,000. When the position is closed, the leverage is repaid, and the trader walks away with a $5,000 profit for the $10,000 in their account. In the same example without leverage, the trader makes only $100 profit for the same market movement. Leverage in forex is a huge part of what makes it so profitable when the markets are moving in your favour.

Of course, the same is true in the reverse. A 1% fall in the market wipes out half your margin, and traders can be expected to stump up the difference if and when margin is called by the broker. In this respect, forex is a highly volatile way to trade, and one not for the faint of heart.

Stock Trading in Practice

By contrast, trading in stocks is a much more pedestrian form of speculation. While leverage in forex runs at 50:1 and beyond, leverage in stocks is typically capped at 2:1. Traders invest in company stocks on the assumption that the value of those stocks will rise with time – as and when this happens, the gap between them is the trader’s profit, i.e. the appreciation of the value of the portion of the company you have purchased.

Unlike with forex positions, there is a secondary way of earning money from stock trading – dividends. Stocks that pay a dividend present an opportunity for the owner to receive a distribution of company profits proportionate to the size of their holding. So if you’ve bought a 0.01% share of a company declaring a dividend of $10 million, you’ll receive $1,000 in dividends as part of the distribution. Stocks will typically have dividend expectations priced in to their premium, but dividend investing can be another strategy for informing buying (and selling) decisions when trading in the stock market.

Typically, stock trading will require more funds to get started – at least if you want to generate decent returns. You will typically be looking towards a longer timeframe for your investment to pay off and will generally experience a much less volatile trading environment than that which you’d see in forex markets. While this is notionally lower risk than trading in forex, and your potential exposure to a position is only as high as the margin you’ve invested, the upside is comparatively much smaller than you could expect from a highly leveraged forex transaction that has tied up the same amount of capital.

Forex Pros and Cons

Forex Trading Pros

  • Start from a low base: Forex accounts can be opened from as little as $100. Due to leverage, it’s possible to grow more quickly from smaller amounts – even $100 at 50:1 allows for positions worth $5,000 per trade.

  • Highly leveraged gains: Any profitable trades bear much more heavily on your trading account when you’re trading with the benefit of leverage. The gains in forex trading are highly leveraged as standard, meaning you’ll make more money more quickly when things are going your way.

  • 24 hour trading: The forex markets never sleep, so there’s potential to trade around the clock. As well as allowing you freedom to make trading decisions at any hour of the day or night, there’s also the opportunity to spot trends and market developments 24/5, allowing you to take advantage of advantageous movements in the markets whenever they arise.

  • Massive Liquidity: Forex markets are highly liquid, so it’s quicker and cheaper to fill your positions – no matter what you’re buying. Compared to stock trading, where the liquidity volumes are much lower, this means you are less exposed to price drift when opening and closing positions.

Forex Trading Cons

  • Highly volatile markets: Currency markets are by their very definition highly volatile. The high degrees of liquidity and the large volumes of transactions mean markets are constantly moving in both directions. Traders need to keep a close eye on developments over the lifetime of their position, and use stop losses, limit orders and other instruments to prevent running into problems.

  • Downsides of leverage: While high leverage can be a blessing, it can also have a disastrous effect on your trading account. As quickly as profits can be made, fortunes can be lost – at 50:1 leverage, any tick against your position can be a cause for concern. With forex, your losses aren’t limited to the capital you have exposed to the position – when you’re so leveraged, you can easily find yourself liable to a much greater extent than would be the case if you were trading pound for pound.

  • Less time in the market: Forex trades tend to be faster paced, meaning you’ll usually make more of them, more frequently than if you were trading in stocks. This means you’ll need to be conducting more frequent and in-depth market research than you necessarily would with other types of investment, simply because the transactional turnover through your trading account will likely be higher. It would be a brave trader who would set a forex position for a number of weeks and leave it to run unchecked. You’ll typically trade over shorter time-frames, and look to make smaller, more frequent gains from opportunities in currency markets when they arise.

  • Less margin for error: When the stakes are amplified by leverage, there is simply less margin for error. Forex traders need to get it right, or they run the risk of account wipe-out. Only through good strategy, proper research and diligent execution is it possible to trade forex successfully for the long-term, and there’s no real scope for making bad decisions. Any wrong turn can cost you dearly when you’re trading with these high degrees of leverage behind you.

Stock Trading Pros and Cons

Stock Trading Pros

  • More stable markets: Stock markets tend to move more slowly than currency markets, with substantially less volatility than you’d face as a forex trader. While this limits your upside potential in most cases, it means you’re also more likely to see losses coming and have more time to adjust your positions accordingly.

  • Lower risk profile: With leverage at a much lower level in stock trading than in forex trading as a rule, the risk profile for investing in stocks pitches at a significantly lower level. It’s like anything in finance – the lower the risk, the lower the reward. Stock trading is the sensible, boring brother of investing in currency. Depending on your risk appetite, your profit motive and the timespan of your trades, either one or the other will be more appealing.

  • Fewer trades: Because stock trades tend to be longer, slower investments, you’ll make fewer trades. Not only does this save on broker fees, but it also tends to mean you’ll require less frequent decision making, with a lower research burden than if you were trading forex. This all comes down to your preferred trading style and the amount of time you want to spend in the market and on the market. For those looking for a more passive trading style, the stock market is a more stable, long-term investment option than any currency pair.

  • Less reliant on technical analysis: Technical analysis, the analysis of price charts and data, is less essential in stock trading than with forex trading. When trading in stocks, there is more scope for fundamental analysis, looking at economic and other external factors and how they are likely to influence company performance – ideal for traders who prefer a less technically minded approach to researching their positions.

Stock Trading Cons

  • Needs more capital: Stock trading requires more capital from the get-go, because leverage is lower. The same percentage gain in a stock position vs a forex position will deliver a return many times lower. It’s not really possible to build a stock portfolio with $1000 – whereas a forex account at $1000 can quickly double, triple or more with the right positions. Stock trading needs to be approached with a larger investment pot.

  • Longer investment time-frames: You’ll typically need to wait longer to see the return from trading in shares as opposed to trading in currency. This means locking your capital in place for longer, and a longer turnaround to seeing a profit from any position you trade. While it’s still possible to engage in shorter term trading strategies with stock trading, positions are almost always more profitable when left over longer durations.

  • Lower liquidity: With much lower daily transaction volumes through share markets, there is lower liquidity around during the trading day (and particularly outside of trading hours) for settling positions. This means you are subject to greater market risk, with the potential for the market to change while you’re waiting for an order to be filled.

What Is Actually Better to Trade: Forex or Stocks?

Deciding which is the best option for your trading depends on a few different factors: namely your appetite for risk, the amount of capital you have to play with, and whether you’re looking for short-term profits or a longer term investment opportunity.

For traders looking to make a profit quickly, or looking to maximise the potential yield from their capital, forex trading is the way to play it. A fast-paced, dynamic market environment where you can radically change your financial fortunes overnight, forex trading offers a level of thrill and excitement that is a much slower burn, if it’s present at all, when trading in stocks. However, the price you pay for that comes in higher risk, and the ever-present threat of the dreaded margin call on your positions, which can test the mettle of even the most hardy trader.

If by contrast you’re looking to invest for a period of months or years, or you’re looking for a much more controlled risk profile overall, stock trading could be the right option for you. The markets are much less liquid, and the upside per trade is comparatively smaller and only ever realised over a much longer time horizon. However, if you have the patience, the right strategy, and a large amount of capital to invest for lower, slower returns, stock trading can still be an effective way to grow your capital and realise a return from your trading activity.