February 10, 2017
If you have ever traded stocks, or seen news headlines about the stock market, you have probably noticed the enormous number of stocks that are available for trading. In fact, there are more than 2,000 stocks listed on the New York Stock Exchange alone! All these stocks are influenced by various factors, like earnings reports, rumors about mergers and acquisitions, and even resignations of CEOs. Multiply this with hundreds or thousands of stocks, and you will pretty soon realize the amount of work and time needed to catch up with all of this.
Now, let’s compare this with the forex market. I have made some bullet points to make it easier to follow:
There Are Only Eight Major Currencies in Forex
As mentioned earlier, eight currencies make up the majority of the daily turnover in the foreign exchange market. These are:
- U.S. dollar (USD)
- British pound (GBP)
- euro (EUR)
- Japanese yen (JPY)
- Swiss franc (CHF)
- Australian dollar (AUD)
- New Zealand dollar (NZD
- Canadian dollar (CAD)
The major currency pairs, (which consist of the U.S. dollar and one of the other seven currencies), have a market share of 72% in forex. You can check the share of total volume by currency pair on the next chart. Let’s stop here for a minute and compare this to the stock market. Eight currencies far easier to follow than thousands of stocks, do you agree?
Most traders focus only on one or a few of the major currency pairs, like EUR/USD, USD/JPY and GBP/USD. Following three charts and four currencies, which I can trade all day long, compared to the limited trading hours and big number of stocks is something that attracted me to the forex market in the first place.
The Forex Market is Open All Day Long, 24/6
Forex is a decentralized market which trades at large financial centers around the world. The largest of them are: New York (U.S. session), London and Frankfurt (European session), and Tokyo and Sydney (Asia-Pacific session). Recently, Hong Kong and Singapore have become large forex centers as well. With the closing of the U.S. session, the Asian session opens, followed by the European session. Notice the overlap in active market hours between London (European session) and New York (U.S. session), this is the most volatile period of the day with the majority of daily volume taking place. Compared to the stock market, the advantage of forex is obvious in this case.
Forex Has No Middleman
Being a decentralized market, forex has no middleman in the usual sense. Forex brokers do have a similar role as stockbrokers on the stock market, but they only charge a small fee in the form of a spread. There is no commission in forex. With the advantage of technology and straight through processing (STP) brokers, which provide direct access to the market, the need for a middleman disappeared.
Forex is Much Harder to Influence than Other Markets
Forex is the largest financial market in the world, with participants including large banks, hedge funds, multinational corporations, investors, to central banks and governments. The size of the market makes it impossible that one single market participant influences the value of a currency in noticeable amount. Compare this with the stock market, where analysts’ discussions or rumors can have a big impact on the price of stocks. In the long run many investors believe this helps to make the analysis of currencies much easier and more predictable than stocks.
Why Traders Choose Forex Over Futures
The same advantages of forex over the stock market, applies to the futures market as well. As noted earlier, forex is always alive. It’s a truly 24-hour market which can be traded almost every day, and dwarfs the $30 billion daily turnover of the futures market. Even on Sunday, you can place trades when the Asian session opens at 5:00 PM in Sydney, and 7:00 PM in Tokyo. Compared to the limited trading-hours of the futures market, this means that trading opportunities in forex exist around the clock.
Another major disadvantage of the futures market over forex are the commissions. In the forex market, brokers only charge a small fee which is called the “spread” – the difference between the bid and ask price for a specific currency pair. Many brokers offer spreads as low as 1 pip on the major currency pairs like EUR/USD, and under normal market conditions. This is the only cost you will have when opening a position in the forex market.
Compare this with the average volatility of currency pairs during the main trading sessions in the next article, and you will see that the spread can be earned back in a matter of seconds if you are on the right side of the price movement. With an increase in market liquidity during some trading sessions, the spread becomes even tighter as there is heavy supply and demand in the market. Trading sessions will be covered in the coming few articles.
When opening a position with a forex broker, you will get fast trade execution and price certainty under normal trading conditions, thanks to the deep liquidity of the market. On the stock and futures market the opposite is true – the price the broker shows for a specific stock or futures contract is the last price at which the instrument has traded, and not necessarily the price at which your order will be opened. This creates price uncertainty which can affect your bottom line.
In the forex market, you can also always have a known risk/reward ratio, thanks to the various types of market orders and guaranteed limited risk. For example, you can open a buy position on GBP/USD with a take-profit level of 100 pips above the current price, and a stop-loss level of 50 pips below the current price. This gives you an exact risk to reward ratio of 1:2. As most traders trade with leverage on forex, this means that a specific amount of trading capital needs to be “locked” while opening a position. This is called the margin. If you trade with a 1:50 leverage, the required margin for opening a position will be 2% of your position size.
A margin call happens when your position goes against you to such an extent that your available margin becomes zero (that is, the free funds which are not locked in your margin). With a margin call, you can’t lose more than your required margin for opening the position in the first place.
Test Your Knowledge: Why Traders Love the Forex Market
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Question 1 of 4
Like traditional stockbroker, a forex broker has commissions, middleman, a fixed lot size and transaction costs.Correct
Question 2 of 4
A pip is the smallest increment a currency pair fluctuates.Correct
Question 3 of 4
The value of a pip can vary with the size of your position, ranging from just a few cents for a small position to a few dollars for a large position.Correct
Question 4 of 4
Which of the following traditionally has the highest volatility when compared to the other pairs.Correct