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5 Reasons to Trade Forex Instead of Stocks |
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While Forex trading is becoming more popular in the UnitedStates, the vast majority of investors still do not understandthe massive advantages offered in the foreign currency marketwhen compared to equities or fixed income trading. When youfully grasp the following concepts, you'll understand why youmight want to reconsider your current investment strategies.
1. Currency prices are not heavily influenced byinstitutional investors. In stock trading, there is alimited amount of volume on a daily basis. Each stock has aspecific number of shares on the open market and trade pricesare governed by the number of people attempting to buy or sellshares at a specific point in time. This makes the marketvulnerable to price swings when a large investor is attemptingto buy up or unload large amounts of shares. For example, ifsome pension fund owns 10% of a company and suddenly decides toliquidate their position, the market is now flooded with sellorders. Since the amount of shares attempting to be sold willoutnumber the amount of buy orders, the price of the stock willstart to drop as the number of buyers days up. This createslosses for the remaining shareholders. On the other hand, theforex market is so massive and has so many investors that nosingle investor can possibly have a major impact on pricing.There are too many units of Euros, Dollars, Yen, etc for anysingle institution to hold even close to a controlling interestin any currency.
2. Margin requirements are significantly lower in forextrading than equity trading. While the exact amount ofmargin allowed is determined by each broker, the restrictionsare usually much less stringent when trading forex. Marginallows the investor to "play with house money." In essence,you're borrowing money from the broker to invest in your ownaccount. While this can be risky, it can also be insanelyprofitable. For example, let's say you have $10,000 of your ownmoney to invest. If you open up a margin account at an equitybroker, you can usually margin up to 50% of the value of stock.So if you buy $10,000 in Microsoft stock, you can borrow another$5,000 to own a total of $15,000 in value. With your forexaccount, the margin requirement is often as low as 1%. Whichmeans that if you buy $10,000 in Euros, you can use yourbroker's money to buy another $1,000,000. So you now own over $1million in Euros. Now lets say that the value of each investmentincreases 10%. Your $15,000 in Microsoft stock is now worth$16,500. You sell it, pay back the $5,000 you borrowed, and youpocket $1,500 in profit (minus any fees or interest). Yourreturn on investment is 15%. If your Euros went up 10%, your $1million is now worth $1.1 million. After selling and repayingyour broker, you profit $100,000 before any interest. That's areturn on investment of over 1,000%. Of course, you need to beextra careful when trading on margin. Imagine if the transactionwent the other way. You'd be in a much bigger hole in the forexscenario. But the potential for enormous gain is there and isone of the major reasons why forex trading is so attractive toserious investors.
3. Forex trading is open 24 hours a day. Unlike the U.S.stock markets, you can trade forex any time of day from Mondaythrough Friday. If a major news story breaks when you're holdingstock, and it's after hours, you're stuck holding onto yourposition until the market opens the next day. By the time thishappens, everyone else knows the news and there's thousands ofbuy/sell orders waiting when the opening bell rings. This willdramatically influence your trade price and negate any advantageyou might have had by being one of the first to react. Keep inmind that many corporations withhold major news such as earningsreports and personnel moves until after the market closes. Theydo this to minimize emotional trading, which is smart for themto do but also hurts savvy investors. Since Forex trading isopen 24 hours, you can place your trade order whenever majorevents occur.
4. The foreign exchange market is more liquid than the equitymarket. Forex is the largest market in the world. Every day,an average of $1.4 trillion dollars is traded, and the amount ofsecurities (foreign currencies) is minuscule when compared tothe number of companies traded in the equities market. Thismeans that there are always buyers to be matched with sellers,which means that you'll have a much better chance to get a fairand accurate price on your trade than if you were trading a lowvolume stock where the bid and ask spreads can be very large.
5. Forex trading offers the advantage of limited risk. This is one of the large advantages over the futures market.When you buy a futures contract, you are obligated to buy orsell a specific amount of a specific commodity at a specifictime for a specific price. Which means that if disaster hits,you're out of luck. For example, lets say you buy a futurescontract to sell corn. If news breaks that reports an outbreakof deaths caused by a pesticide used in corn crops, the price onyour contracts will drop through the floor, limits will drop,and you could be stuck in your position and end up takingmassive losses. This would not happen in the forex market sinceyou can leave your position at any time.
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