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5 Reasons to Trade Forex Instead of Stocks
from: Francis GillenWhile Forex trading is becoming more popular in the United
States, the vast majority of investors still do not understand
the massive advantages offered in the foreign currency market
when compared to equities or fixed income trading. When you
fully grasp the following concepts, you'll understand why you
might want to reconsider your current investment strategies.
1. Currency prices are not heavily influenced by
institutional investors. In stock trading, there is a
limited amount of volume on a daily basis. Each stock has a
specific number of shares on the open market and trade prices
are governed by the number of people attempting to buy or sell
shares at a specific point in time. This makes the market
vulnerable to price swings when a large investor is attempting
to buy up or unload large amounts of shares. For example, if
some pension fund owns 10% of a company and suddenly decides to
liquidate their position, the market is now flooded with sell
orders. Since the amount of shares attempting to be sold will
outnumber the amount of buy orders, the price of the stock will
start to drop as the number of buyers days up. This creates
losses for the remaining shareholders. On the other hand, the
forex market is so massive and has so many investors that no
single investor can possibly have a major impact on pricing.
There are too many units of Euros, Dollars, Yen, etc for any
single institution to hold even close to a controlling interest
in any currency.
2. Margin requirements are significantly lower in forex
trading than equity trading. While the exact amount of
margin allowed is determined by each broker, the restrictions
are usually much less stringent when trading forex. Margin
allows the investor to "play with house money." In essence,
you're borrowing money from the broker to invest in your own
account. While this can be risky, it can also be insanely
profitable. For example, let's say you have $10,000 of your own
money to invest. If you open up a margin account at an equity
broker, 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 forex
account, the margin requirement is often as low as 1%. Which
means that if you buy $10,000 in Euros, you can use your
broker's money to buy another $1,000,000. So you now own over $1
million in Euros. Now lets say that the value of each investment
increases 10%. Your $15,000 in Microsoft stock is now worth
$16,500. You sell it, pay back the $5,000 you borrowed, and you
pocket $1,500 in profit (minus any fees or interest). Your
return on investment is 15%. If your Euros went up 10%, your $1
million is now worth $1.1 million. After selling and repaying
your broker, you profit $100,000 before any interest. That's a
return on investment of over 1,000%. Of course, you need to be
extra careful when trading on margin. Imagine if the transaction
went the other way. You'd be in a much bigger hole in the forex
scenario. But the potential for enormous gain is there and is
one of the major reasons why forex trading is so attractive to
serious 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 Monday
through Friday. If a major news story breaks when you're holding
stock, and it's after hours, you're stuck holding onto your
position until the market opens the next day. By the time this
happens, everyone else knows the news and there's thousands of
buy/sell orders waiting when the opening bell rings. This will
dramatically influence your trade price and negate any advantage
you might have had by being one of the first to react. Keep in
mind that many corporations withhold major news such as earnings
reports and personnel moves until after the market closes. They
do this to minimize emotional trading, which is smart for them
to do but also hurts savvy investors. Since Forex trading is
open 24 hours, you can place your trade order whenever major
events occur.
4. The foreign exchange market is more liquid than the equity
market. Forex is the largest market in the world. Every day,
an average of $1.4 trillion dollars is traded, and the amount of
securities (foreign currencies) is minuscule when compared to
the number of companies traded in the equities market. This
means that there are always buyers to be matched with sellers,
which means that you'll have a much better chance to get a fair
and accurate price on your trade than if you were trading a low
volume 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 or
sell a specific amount of a specific commodity at a specific
time for a specific price. Which means that if disaster hits,
you're out of luck. For example, lets say you buy a futures
contract to sell corn. If news breaks that reports an outbreak
of deaths caused by a pesticide used in corn crops, the price on
your contracts will drop through the floor, limits will drop,
and you could be stuck in your position and end up taking
massive losses. This would not happen in the forex market since
you can leave your position at any time.
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