Stock Trading vs Forex Trading: Which is riskier? - Eaglesinvestors

Asking which is riskier, stock trading or forex trading, is almost always going to invite the answer ‘It depends’. It depends on the strategy an individual trader prefers, the amount of capital they invest in their trades initially and the amount of time they have to devote to monitoring their activity and reacting to changing circumstances.

Stock Trading vs Forex Trading

On a surface level, trading in forex is always going to seem like the ‘riskier’ option, in that it depends upon taking short term decisions and attempting to profit from quick and often quite small movements in the relative strength of different currency pairs. Trading in stocks, on the other hand, involves taking a longer-term view of the stability and worth of a specific company or basket of companies. Comparing the two isn’t simply a question of contrasting the risk factor inherent in each it is about weighing up the pros and cons of the two different types of trading and deciding which type of risk is more suited to your trading style and your ambitions.

No matter which type of trading you do finally opt for, the best piece of advice is to do your research before putting any of your actual capital on the line.

Stock Trading

In the case of stock trading, this will mean looking extremely carefully into the stocks which you’re thinking of investing in. Not only will you need to examine the history, recent performance and future plans of the individual company in question, you will also have to take a more strategic, longer-term view of the industry in which it plays a part. Most stock investment in the long term in nature, and depends upon an assumption that the stock market delivers a consistent rate of return.

Taken as an average, stocks generate returns of 7%-10% per annum, but this figure assumes the trader in question has adopted an efficient trading strategy. The 7%-10% average is based on long term trends and takes into account the fact that in some years – 2008 being a notable recent example – the value of the FTSE 100 across the board can slump dramatically. The figure also assumes that a trader reinvests a percentage of any dividends they receive, and that panic selling doesn’t take place during periods of downward movement.

The truth of the matter is that many traders, if they haven’t taken the time to develop a coherent long-term strategy, often adopt a policy of investing heavily when the market is moving upward and then selling in a panic when a downward shift occurs. Individual traders also have a tendency to invest in companies or sectors in which they have a particular personal interest, rather than diversifying across a range of options.

The other aspect which plays a vital role in successful stock trading is the ability to take a long-term view of geo-political or even societal changes. Current investment decisions, for example, need to take account of the fact that the biggest effect on global economic growth during the next 30 years is expected to be the impact of climate change. Many of the predictions regarding the effect which climate change will have on the global economy over the coming years are based upon an assumption that the negative effects will heavily outweigh anything positive. In contrast to this, however, investments in the green and renewable energy sectors are almost bound to perform extremely well as the extent of any climate emergency becomes clearer and action is taken. This is just one example, but it helps to illustrate how the risk factor inherent in trading stocks and shares is hugely influenced by the degree to which a trader has been willing to do their homework.

The pros of stock trading

The sheer number of stocks available – there are literally thousands of stocks available to invest in, and while this may seem somewhat overwhelming to the individual trader trying to make a choice, it also means that it is simpler to diversify across sectors, mixing those that move in a cyclical or seasonal nature with those that perform in a steadier, long term manner.

Relative low volatility – the relatively stable nature of many stocks – particularly those of larger companies – means that the market is generally a good place to learn the ropes of trading.

Regulation – because it takes place via marketplaces such as the London Stock Exchange, trading in stocks is highly regulated and therefore regarded as a safer option that trading forex over the counter.

The cons of stock trading

Liquidity – some smaller stocks can sometimes have poorer liquidity, making them harder to buy and raising the initial cost.

Fees – the fees for trading stocks can be higher than other types of trading, as the need to cover the costs of a broker has to be factored in.

Forex

Trading forex rather than stocks generally means taking a shorter-term view and, in some cases, buying and selling pairs of currencies in a matter of seconds in response to shifts in the market which have yet to be factored in more widely. As with trading stocks, reducing the risks involved depends upon taking the time to study the pairs of currencies you wish to trade in, and noting the kind of economic, political and societal changes which might cause a currency to strengthen or weaken. The obvious example to give in the current climate is the impact which Brexit is having on the value of the pound and, in particular, the fact that any statements indicating a shift toward a no-deal Brexit tend to send the pound plummeting against the dollar and the euro. A clever forex trader may note, for example, that a particular cabinet minister is giving an interview on the Today programme on Radio 4 and might set up positions based on the assumption that the minister is going to re-affirm the government commitment to no-deal Brexit preparations.

Risks of Forex Trading

The risks of forex trading tend to centre upon the volatility of the markets and the fact that this volatility sometimes makes it difficult for a trader to close a trade exactly when they would like to. The other big risk factor is the leverage involved in forex trading. This means investing a particular amount of capital and then being able to multiply the purchasing power of that capital. For example, a trader with a capital of £500 could be offered leverage of 30:1, which would enable them to take up positions which multiply £500 by 30 to create £15,000. This instantly opens up the possibility of far greater profits, but at the same time it ratchets up the possible losses.

One of the key factors which mitigate any risk inherent in forex trading is the fact that retail traders can shop around for the broker of their choice and can select one which offers a free demo option to enable traders to develop their strategy and technique before putting any of their capital on the line.

Conclusion

As can be seen, the question of ‘risk’ when applied to different types of trading is more complex than simply stating that one is more or less risky than the other. The risk which any individual trader is facing will depend upon the trading strategy they adopt, and the key to successful trading lies in learning – through a combination of study and experience – how to handle that risk.

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