People who want to invest in the financial markets have some confusion due to the wide range of existing financial products.
The foreign exchange market or forex market is growing rapidly and is becoming very popular among small investors. The best-known market is the stock exchange, where the shares of the country’s major companies are listed. But more and more the best forex trading platform is gaining ground against the stock market.
The doubt that people who want to invest their savings in the financial markets have been whether to do it in the stock market or to do it in forex. So, the typical question is, what is the difference between forex and the stock market?
These financial instruments are very different, and both have different levels of risk. Some investors invest in the stock market and want to switch to forex, and many doubts arise.
The internet is full of hoaxes and half-truths about the financial markets. Yes, you can indeed earn a lot of money in certain very specific circumstances, which are not the usual ones. Therefore, you should be aware that investments in stocks and currencies are high risk. If you do not know how to manage the risk, you can lose all your capital.
The difference between forex and the stock market
Location of the financial markets
In the past, investors used to meet physically at the stock exchanges to negotiate the exchange of listed securities. Today, the vast majority of transactions are done over the internet. Purchases and sales of securities are recorded in a register.
The foreign exchange or forex market does not have a physical Transactions are done privately between buyers and sellers. Everything is done electronically through a broker.
Capital to invest in forex and the stock market
Investing in stocks requires much more capital than investing in the forex market. The forex market is a little more complicated to understand than the stock market. However, once you understand the basics of how it works, and learn a minimum of technical analysis, you will be ready to invest.
The great advantage of the Forex market is the leverage offered by brokers. Leverage means that with little capital, you can make important investments since the broker lends you the money. This is a tool that you must learn to use conveniently. With leverage, you can have impressive returns, but also considerable losses.
Here is an example to help you understand why you need less capital in forex than in the stock market:
Example of stock investment
In the example, we will not consider the commissions charged by the broker.
Imagine that you buy a share at 1,000 and sell it at 1,050, which is a 5% return. Let’s take a look at it:
Leverage: In the stock market you have no leverage.
Total investment: Capital X leverage = 1.000 x 1 = 1.000 €.
Total profit: Profit – Investment = 1.050 – 1.000 = 50 €.
Profitability = (Total Profit / Investment) x 100 = (50 / 1,000) x 100 = 5%.
Example of forex investment
In the example, we will not consider the commissions or the spread charged by the broker.
Imagine that you invest 1.000 ¤ buying the EUR/USD pair and sell it with a profit of 5%. With the leverage effect you will see that your profitability is much higher than 5%:
Leverage: let’s say your broker offers you a leverage of 1:100
Total investment: Capital X leverage = 1.000 x 100 = 100.000 €.
Total profit: Profit – Investment = 105.000 – 100.000 = 5.000 €.
Profitability of your investment = (Total profit / Investment of your money) x 100 = (5.000 / 1.000) x 100 = 500%.
The difference in profitability between forex and the stock market
As you can see in the example, the leverage effect that forex provides can generate a lot of profitability with little capital. For this reason, forex investment can be better than stock investment if done right.
Of course, in the same way, that it can give you spectacular profits, it can also eat your capital in the same proportion. That is why you must train yourself and learn how to manage the risk before starting to operate in this market.
Broker commissions
The commissions charged by brokers differ between the forex market and the stock market. Another advantage of the forex market is that the commissions are lower than in the stock market.
Stockbrokers will charge you for the entry and exit of the investment. In addition, they will usually charge you a periodic commission for having your trading account.
As billions and billions of dollars are moved every day in forex, the costs of each transaction are usually very tight.
A forex broker will charge you the spread, which is the difference between the bid and ask price of a currency pair. Some brokers may also charge a small commission per trade.
The main currencies in the forex market are EUR, USD, GBP, JPY, CHF, and CAD. As these currencies are heavily traded every day all over the world, there is always liquidity, i.e., there is always some investor in the world willing to buy or sell a currency. That is why forex commissions are so low compared to stocks.
It is often said that investing is when you buy an asset because you trust that in the long term it will increase in value. On the other hand, it is said that speculating is when you buy something to sell it quickly to obtain a profit.
From our point of view, everything is speculation. But well, politically it seems nicer to say that the bad guy is the speculator, and the good guy is the investor. But isn’t the investor speculating?
Continuing with the topic, in the forex market, in general, it is not usual to hold positions for a long time. There are even some traders who make investments of hours or even minutes. That is why it is said that the forex market is more speculative than the stock market.
When you buy shares of a company, you usually do it to keep them over time because you think they will rise in value. Some people buy shares and keep them for many years.
With shares, you can also make very short-term operations, but the commission costs are much higher, and you also need significant capital to make this type of investment, since you do not have leverage.
To each their own
From our point of view and my years of experience in the financial markets, we find forex much more attractive for small investors.
Of course, forex is more speculative than the stock market. You have to see which market best suits your personality, your situation, and most importantly, your knowledge.