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Chapter 16. Comparison of Forex and Stock Market
In trading on financial markets, like in any field, there are supporters and opponents of specific directions. Financial markets include the gold market, the stock market (securities market), Forex (currency market), and various commodity markets. It is not possible to consider a particular financial market in isolation from others since all processes in the global economy are interconnected in one way or another. The situation in the stock market can significantly impact currency exchange rates in Forex, which, in turn, can influence the gold market. The reverse statements can also be true. In this chapter, we will limit ourselves to comparing the Forex currency market and the stock market, exploring the advantages and disadvantages of each for its participants (brokers, dealers, internet traders).
In the previous chapters, we thoroughly studied the fundamentals of the Forex currency market. Now let's familiarize ourselves with the stock markets. Stock markets trade financial instruments, also known as securities. A security is a document representing ownership of capital, with the right to dispose of it permanently or temporarily transferred to other individuals in exchange for the right to participate in the profits generated by that capital. In other words, when we acquire a security, we invest our money in something that, according to our expectations, should generate a profit. Therefore, financial instruments are documents that contain certain ownership rights, which can be realized upon presentation. The main types of securities include stocks, bonds, derivative securities (warrants, futures, options), savings and deposit certificates, and promissory notes. Let's briefly discuss each of these types of securities.
Stocks are the primary type of securities and represent the ownership rights of their holders in a company's profits. The holder of a stock essentially owns a share in the capital of the corporation. There are different types of stocks, including registered shares, bearer shares, common stocks, and preferred stocks. The first two types are self-explanatory. Common stocks grant voting rights at shareholders' meetings, and the amount of dividends paid is determined by the annual financial performance of the corporation. Preferred stocks receive fixed dividends but do not grant voting rights at shareholders' meetings. As you can see, stocks provide their owners with not only ownership rights but also the right to receive income in the form of dividends
A bond is a debt security that confirms the lending of funds to the issuer (the entity issuing the bonds) in exchange for the right to receive profits in a specified manner. Typically, profits are obtained in the form of a fixed annual percentage of the issuance value or the face value of the bond. There are government bonds and corporate bonds. Government bonds are more secure but less profitable, while corporate bonds, on the other hand, are more profitable but less secure. As with any investment, the yield and risk of owning bonds are directly related - the higher the risk, the higher the yield.
Like in Forex, the stock market also has derivative financial instruments. We have already discussed derivative instruments in Forex in the corresponding chapter, and now let's talk about derivative instruments in the stock market.
A warrant is a valuable security that defines the rights to buy/sell shares under certain conditions or to exchange them for shares.
A futures contract is a valuable security that represents a standardized contract to buy/sell a specified quantity of shares in the future at a price fixed at the time of entering into the futures contract. Both the buyer and the seller of the shares are obligated to fulfill the conditions of the futures contract. To guarantee the fulfillment of the futures contract conditions, both parties must provide collateral, the size of which is determined by the exchange and held by the exchange where the transaction takes place.
An option is a valuable security similar to a futures contract, except that it does not impose obligations on the buyer but only grants the right to exercise them. An American-style option grants this right for a certain period, while a European-style option grants this right upon the expiration of a specific period. On the other hand, the seller of the option is obligated to fulfill the contract conditions and therefore bears a certain risk. The buyer of the option pays a premium to the seller for this risk. If the buyer ultimately refuses to exercise the contract conditions, they lose this premium. To guarantee the fulfillment of the option contract conditions, the seller provides collateral, which, like in the case of futures contracts, is determined by the exchange and held by the exchange. In essence, the subject of trading in options is the premium paid by the buyer.
Securities also include certificates. A certificate is a written document issued by a bank that certifies a deposit of funds, giving the depositor the right to receive the deposited amount and accrued interest after a certain period. A deposit certificate is issued when the depositor is a legal entity, while a savings certificate is issued when the depositor is an individual.
A bill of exchange, or promissory note, is a type of debt instrument that grants the right to demand payment of a specified amount upon its maturity date. There are two types of bills of exchange: simple and negotiable. A simple bill of exchange is a promise to pay a certain amount issued by the debtor and transferred to the creditor. On the other hand, a negotiable bill of exchange (also known as a draft) is issued by the creditor and must be either accepted or protested by the debtor. Upon acceptance, the debtor agrees to pay the specified amount stated in the bill.
Now that we have discussed the financial instruments traded in the stock market, let's delve into the specifics of such trading. Unlike the Forex market, the stock market has a spatial limitation—the trading takes place on a stock exchange. Stock exchanges are located in major financial centers around the world, and the variety and quotations of stocks on different stock exchanges may vary. However, with the development of telecommunications and the Internet, stock exchanges have the capability to promptly exchange quotations, minimizing the need for arbitrage operations. Arbitrage operations involve buying stocks on one stock exchange and subsequently selling them on another exchange at a more favorable rate. In the Forex market, arbitrage operations are not possible because the currency market does not have centralized trading venues.
To execute buying or selling transactions in the stock market, it is necessary for the buyer and seller to find each other. Due to the limited number of participants on a single stock exchange, the liquidity of stock transactions is much lower compared to currency operations in the Forex market. On a stock exchange, you may not find a buyer for your stocks and may incur significant losses if the price of your stocks declines sharply. Unlike the Forex market, where profit can be obtained through speculative operations in both rising and falling markets, in the stock market, profit can only be achieved by anticipating an increase in stock prices. In other words, you need to buy stocks at a lower price first to sell them at a higher price later. It is not possible to sell stocks that you don't own initially. However, there are mechanisms to bypass this limitation, such as engaging in short selling, which involves selling securities you do not own with an obligation to repurchase them later. This service is provided by exchange intermediaries to private traders in the stock market.
In the stock market, you cannot take advantage of margin trading as you can in the Forex market. You can only buy stocks with the funds you have available. After all, stocks can be purchased not only for speculative purposes. As mentioned before, stocks represent ownership in a company, provide voting rights at shareholder meetings, and offer dividend payments. Therefore, you may buy stocks without the intention of selling them later. In such cases, the concepts of open and closed positions lose their meaning, as well as the provision of leverage and margin trading for traders.
Unlike the Forex market, which operates 24/7, the stock market has specific opening and closing hours. These hours are determined by the operating hours of the respective stock exchange (typically 8 hours on business days) where the trading takes place. If you use the internet for stock trading and are located in a different time zone from the stock exchange, it can be inconvenient. The trading hours of the stock exchange may fall during the nighttime in your region, forcing you to adjust your lifestyle accordingly. Therefore, in the Forex market, with its round-the-clock operation, you have more flexibility in conducting your trades.
To be successful in the stock market, it is not enough to rely solely on the analysis mechanisms used in the Forex market. Technical analysis and fundamental analysis can be used to forecast changes in stock prices, but microeconomic factors that impact a company's performance also play a significant role. Access to financial statements, information about personnel changes within the company, and government contracts for its products is necessary to make informed decisions regarding buying or selling stocks. If we are talking about foreign companies, such information is only available from international sources such as television, newspapers, magazines, and published financial statements. Naturally, this information is published in foreign languages, which presents significant challenges in studying and understanding it.
It should be noted that, unlike the financial instruments in Forex, the financial instruments of the stock market discussed here have their own advantages. These include receiving dividends from stocks, participating in company management, redemption of government securities, and coupon payments on bonds. These advantages partially mitigate the risk of losses when operating in the stock market.
In this chapter, we have attempted to compare the Forex market and the stock market. We have found that each has its own advantages and disadvantages, and each is attractive to investors in its own way. In the next chapter, we will explore the correlation between these markets and understand how forecasting in one market can aid in making buying/selling decisions in the other.