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5 Reasons to Trade Forex
Instead of Stocks
By
Francis Gillen
While 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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