Newcomers to trading get a tad excited when they realize that leverage allows them to increase their so-called skin in the game.
However, they often fail to recognize the risks attached to enhanced positions, and when the market moves against them, they are left high and dry.
The truth is that leverage *can* be a useful asset to traders when used carefully – particularly in strategies like forex scalping. More on that later in this article.
So, it’s useful to know about the perks and the downsides of leveraged trading, and it also pays to know how much leverage you can expect to be offered across the various asset classes.
Risk and reward
It’s worth noting that leverage rates tend to be higher in forex than stock trading – and with most other forms of investment, for that matter.
You can use up to 100:1 in your leveraged positions, which means that even with trading capital of $100, you can open trades with as much as $10,000 in hand.
For all the excitement and upside potential that brings, it comes matched by a correlating amount of risk and possible downside.
The key is to implement strict stop-losses to ensure that your leveraged downturn does not become a disaster, and those that utilize the forex scalping strategy mentioned earlier should use tighter open and close margins to protect against sharp price movements.
When it comes to stock trading, one of the key differences is that the leverage offered is generally a lot lower, as little as 20:1 in some cases. The same rules of engagement apply – risk should be managed through the use of stop-loss markers, but clearly the fear factor, as well as the upside, is lower when trading stocks in comparison to foreign currencies.
Forex vs stock trading: Asset availability
One of the perks of both forex and stock trading is the great availability and diversity of assets that can be invested in, when compared to those that favor natural resources and the like.
A conservative estimate puts the number of forex pairs available to trade at 300+, while it feels as though there’s an almost infinite number of firms listed on the Nasdaq and other stock markets.
That creates a number of opportunities for traders. It means that more value opportunities are available – we’re not scrabbling around opening positions that are too risky simply due to a scarcity of options.
Of course, there’s a key difference. When it comes to forex trading, only a handful of currency pairs are classed as majors, with the rest considered minor or exotics. Those are volatile and often suffer from a lack of liquidity, so to that end, we might describe stocks as offering a greater availability of choice and opportunity.
Forex vs stock trading: Market volatility
Let’s be honest: all markets can suffer from volatility and unexpected fluctuations.
Of course, volatility presents opportunities – particularly for short-term traders looking to nip in and out with buys and shorts – and so we shouldn’t consider the ‘v’ word as completely negative!
However, the general consensus is that keeping volatility to a minimum is useful, and to that end, perhaps forex trading just has the edge on stocks.
That’s not to say that foreign currencies aren’t subject to unpredictable swings, but there are safe haven pairs – such as the Swiss Franc and Japanese Yen matched with the US Dollar – that investors tend to buy into when the global economy takes a dip.
Is there such a thing as a safe haven stock? Some would argue that Microsoft and Apple share those characteristics, but even they have bumped up and down in value in the past few years.
Forex vs stock trading: Liquidity
The key thing for traders that don’t want to hold a position for months on end is liquidity – how easy is it to get your money in and out of the market without being penalized by wide spreads?
Both the financial and stock markets tend to be incredibly liquid, however it should be noted that many of the minor and exotic forex pairs do lag behind when it comes to liquidity. For example, an estimated 75% of all the traded currency pairs on the planet include USD – go beyond this, and you are looking at tougher trading conditions.
In these instances, you will eat into your profitability when closing a position – in some cases, you may not even be able to close effectively if liquidity is too low.
There’s no definitive answer to the question ‘what is better to trade – stocks of forex?’ But considering leverage, liquidity and other market conditions will confirm the best route for you to take in your trading.