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Differences Between Forex and Equities
A major difference between the forex and equities markets is the number of
traded instruments: the forex market has very few compared to the thousands
found in the equities market. The majority of forex traders focus their efforts on
seven different currency pairs: the four majors, which include (EUR/USD,
USD/JPY, GBP/USD, USD/CHF); and the three commodity pairs (USD/CAD,
AUD/USD, NZD/USD). All other pairs are just different combinations of the same
currencies, otherwise known as cross currencies. This makes currency trading
easier to follow because rather than having to cherry-pick between 10,000 stocks
to find the best value, all that FX traders need to do is “keep up” on the economic
and political news of eight countries.
The equity markets often can hit a lull, resulting in shrinking volumes and activity.
As a result, it may be hard to open and close positions when desired.
Furthermore, in a declining market, it is only with extreme ingenuity that an
equities investor can make a profit. It is difficult to short-sell in the U.S. equities
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market because of strict rules and regulations regarding the process. On the
other hand, forex offers the opportunity to profit in both rising and declining
markets because with each trade, you are buying and selling simultaneously, and
short-selling is, therefore, inherent in every transaction. In addition, since the
forex market is so liquid, traders are not required to wait for an uptick before they
are allowed to enter into a short position - as they are in the equities market.
Due to the extreme liquidity of the forex market, margins are low and leverage is
high. It just is not possible to find such low margin rates in the equities markets;
most margin traders in the equities markets need at least 50% of the value of the
investment available as margin, whereas forex traders need as little as 1%.
Furthermore, commissions in the equities market are much higher than in the
forex market. Traditional brokers ask for commission fees on top of the spread,
plus the fees that have to be paid to the exchange. Spot forex brokers take only
the spread as their fee for the transaction. (For a more in-depth introduction to
currency trading, see Getting Started in Forex and A Primer On The Forex
Market.)
By now you should have a basic understanding of what the forex market is and
how it works. In the next section, we'll examine the evolution of the current
foreign exchange system.
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