How Does the Forex Market Differ from Other Markets?
3 min read
Forex market and other markets have more differences that you can imagine. The difference may appear to be great between the forex market and other markets. But this is not to suggest that they are similar. Not many of the experienced traders have dared to crossover the boundaries of their trusted market domains unless they made sufficient preparations and studied the new market.
The answer is yes. But with some hints on trading style. Also, with a recognition of the differences between the two types of market.
The forex aims to favor short-term trades.
Unlike stocks, futures or options, currency trading does not take place on a regulated exchange. It is not controlled by any central governing body. There are no clearing houses to guarantee the trades. Also, there is no arbitration panel to decide disputes. All members trade with each other based on credit agreements.
Let’s see how the forex market differs from stock markets.
So here are the differences between the Forex market and others.
- The forex market is 24 hours opened, unlike the stock market. It is not a country or geographically particular specified. Major markets open in Tokyo. When it closes, London takes over and then the New York market goes live till the next day when the Tokyo market opens again. This kind of continuity isn’t available in case of stock trading.
- Forex market is the global largest exchange market. Not even the transactions of the entire world’s equity markets’ put together can meet this. The liquidity is never questionable, for example.
- The equity market is ruled by a number of technical and microeconomic parameters and indices. In the forex market, there is no such thing.
- The above point also characterizes that the concept of single exchange trading as nullified and what takes its position is over-the-counter trading.
- There are no commissions to be paid to the brokers. The reason is simple. Traders are directly dealing with currency.
- Currencies can decrease over long periods but can never be zero. This is an extremely incredible situation in the forex market. The traders can hold their short positions for as long as they possibly can without the danger of getting their capital wiped out.
On various stock exchanges around the world, there are hundreds of large companies with shares that are very liquid. On the other hand, for example, the S&P 500 or FTSE 100, there are only three major currency pairs: EUR/USD, USD/JPY and GBP/USD. But, USD/CAD, AUD/USD and USD/CHY are also very prominent pairs and they take place in the forex market.
Spreads on these main pairs are the closest. Hence, they are the most suitable for day traders and scalpers because the transaction costs are lowest. However, for longer-term traders, attractive possibilities can occur nearby more exotic currencies such as NOK, SEK, SGD, and NZD. But, spreads will be wider on pairs involving ‘exotics’ as liquidity is much lower.
This concentration gives traders the possibility to specialize. For example, some will only trade EUR/USD or GBP/USD and become skilled on just one of those pairs.
Stock market traders can decide to specialize just in a few very liquid stocks.
However, those strategies also typically involve having to monitor the major equity indexes. There are software programs that can locate those fast-moving shares, but a lack of specialization in those stocks can leave traders open to making losses.
Trading in the Forex market is cheaper
The spreads on the major currency pairs tend to be wedge thin and closer than on stocks. This makes for cheaper transaction costs, which is important. Moreover, there is no commission to pay on forex trades. Maybe that’s the reason why the forex market is many times bigger than the world’s equity markets.
Also, competition between forex platforms is powerful.
Shorting stocks through stockbrokers can be difficult and very costly.
However, shorting stocks can be very dangerous and far more so than for currencies. Consider shorting the stocks of a company where a takeover bid is announced after trading hours. That means a trader can’t cover their short position until the market opens again.
Takeovers regularly happen at a premium to the day’s share price. It’s not unusual for shares to rally 40% even 100% under such conditions. That can destroy a trader’s capital, especially if leverage is involved.
Higher leverage and lower transaction costs provide the possibility to trade successfully with less capital than required for stocks.
The Forex market is different from other markets in some other key ways too.
Think that the EUR/USD is going to go downward? Short the pair!
There is no uptick rule in Forex as there is in stocks. There are no limits on the size of your position.
For example, if you have enough capital, you could sell $200 billion worth of currency.
More benefits, if you get information that the Bank of England is planning to raise rates at its next meeting, you could go right ahead and buy as many pounds as you like.
No one will ever sue you for insider trading should your bet pay off. There is no such thing as insider trading in Forex.
In fact, some countries economic data, are often known days before they are officially released.
But remember that Forex is a leveraged product. Hence, there is a great chance that you will incur more losses because you can control a large amount of currency with a small margin.
For example, a 1:200 leverage means you will receive $200 in your account for every $1 you invested. If you invest $1000, you would be able to control $200,000 worth of currency trade. Money management is important to profit in Forex trading. You need to plan your risks, learn how to apply stop, losses and practice diversification in your trading practices.
The bottom line
Forex traders are closely watching the price changes, the volume of trades over time. It is important to take note of the price patterns to determine buying opportunities and risks. It is also important for a trader to understand the intrinsic risks, read the disclosures before making a trade.