Chapter 16. Comparison of Forex and Stock Market

In trading on financial markets, as in any business, there are supporters and opponents of separately taken directions. Financial markets include gold market, stock market (securities market), Forex (currency market), various commodity markets. It is impossible to consider one or another financial market in isolation from others, as all processes in the world economy are interconnected in one way or another. The situation on the stock market can significantly affect the exchange rates on the Forex (currency market), which, in turn, can affect the gold market. The opposite can also be true. In this chapter, we will limit ourselves to comparing the Forex currency market and the stock market, finding out the advantages and disadvantages of each of them for their participants (brokers, dealers, Internet traders).

 

Before this chapter we have already thoroughly studied the basics of the Forex currency market. Now let’s familiarize ourselves with the stock markets. Stock markets trade stock instruments, or, as they are called, securities. A security is a kind of evidence of ownership of capital, the right to dispose of which is transferred on a permanent or temporary basis to other persons for the right to participate in the profits produced by this capital. In other words, by purchasing a security we are investing our money in something that we expect to make a profit. Thus, stock instruments are documents containing any property rights, the realization of which is possible upon presentation. It is accepted to distinguish the following main types of securities: stocks, bonds, derivative securities (warrants, futures, options), savings and deposit certificates and promissory notes. Let’s say a few words on each of the varieties of listed securities.

Shares are the main type of securities and determine the ownership rights of their holder to a part of the profit of a joint-stock company. The holder of a share, in fact, has a share in the capital of a joint stock company. There are registered shares, bearer shares, ordinary shares and preferred shares. The first two varieties speak for themselves. Ordinary shares give the right to vote at the general meeting of shareholders, and the amount of dividends paid is determined by the annual financial results of the joint stock company. Preferred shares pay fixed dividends, but they do not give the right to vote at the shareholders’ meeting. As can be seen, shares give their owners not only the right to capital, but also the right to receive income in the form of dividends.

A bond is a debt security. It confirms the fact of lending to the issuer (the one who puts bonds into circulation) money in exchange for the right to receive profit in a specially specified way. As a rule, the profit is received in the form of a fixed annual percentage of the issue value or the face value of the bond. A distinction is made between government and corporate bonds. Government bonds are more reliable but less profitable. Corporate bonds, on the other hand, are more yielding but less reliable. As in any other business, the yield and the risk of owning bonds are directly related – the higher the risk, the higher the yield.

Like Forex, the stock market has derivative financial instruments. Forex derivatives have already been discussed in the relevant chapter, now let’s talk about stock derivatives. Warrant is a security that defines the rights to buy/sell shares on certain conditions or exchange for shares. Futures is a security that is a standard contract to buy/sell a certain number of shares in the future at a price fixed at the time of the futures conclusion. Both the buyer and the seller of the stock are obliged to fulfill the terms of the futures contract. In order to guarantee the fulfillment of the futures terms, both parties must pay a deposit, the amount of which is set by the stock exchange and is kept at the exchange where the transaction takes place. An option is a security similar to a futures, except that it does not impose obligations on its buyer, but only gives the right to fulfill them. The American type of option gives such a right within a certain period of time. The European type of option gives this right after a certain period of time. The seller of the option is obliged to fulfill the terms of the contract and therefore bears a certain risk. For this risk, the option buyer pays a premium to the option writer. If the option buyer ultimately refuses to fulfill the terms of the deal, he loses this premium. In order to guarantee the fulfillment of the terms of the option transaction, the seller pays a deposit, which, as in the case of futures, is set by the exchange and kept at the exchange. In fact, the subject of option trading is the amount of premium paid by the buyer.

Securities also include certificates. A certificate is a bank’s written certificate of deposit of funds that entitles the depositor to receive, after a certain period of time, the amount of the deposit and accrued interest thereon. A certificate of deposit is issued if the depositor is a legal entity. A savings certificate is issued if the depositor is a natural person.

A bill of exchange is a type of debt obligation that gives the right to demand payment of the amount specified in it upon expiration of the term for which it is issued. There is a distinction between promissory notes and bills of exchange. A promissory note is a promise to pay a certain amount, which is written out by the debtor and given to the creditor. In contrast, a bill of exchange (tratta) is written by the creditor and must be either accepted or protested by the debtor. If accepted, the debtor agrees to pay the amount specified by the bill of exchange.

 

Now that we have understood what financial instruments are traded on the stock market, let’s understand the peculiarities of such trades. Unlike Forex, the stock market has a spatial limitation – the place of trading is a stock exchange. Stock exchanges are located in major financial centers of the world, and the variety and quotations of shares on different stock exchanges may differ. However, with the development of telecommunications and the Internet, stock exchanges have been able to exchange quotes quickly to minimize arbitrage operations. Arbitrage operations involve buying shares on one stock exchange and then selling them on another at a more favorable rate. At Forex, arbitrage operations are impossible due to the fact that the currency market does not have centralized trading venues.

Buy/sell transactions on the stock market require the buyer and seller to find each other. Due to the fact that the number of participants on one stock exchange is limited, the liquidity of stock transactions is much lower than with currency transactions on Forex. On a stock exchange you may not find a buyer for your shares, and you may suffer significant losses if your shares fall in price. Unlike Forex, on the stock market you can get profit on speculative operations only by focusing on the rate increase. In other words, you must first buy a stock at a cheaper price in order to sell it at a more expensive price. It is impossible to first sell a stock that you do not own. However, there are mechanisms to circumvent this limitation, when you can make a fictitious sale of securities without having them in stock, with the obligation to make a reverse operation – such a service is provided by exchange intermediaries to private traders of 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 cash you have on hand. After all, stocks can be purchased for more than just speculation. As mentioned above, shares give the right to the capital of the organization, allow you to participate in voting at the general meeting of shareholders, dividends are paid on them. Therefore, you can buy shares and not for the purpose of their subsequent sale. In this case, the concept of open and closed position loses its meaning, as well as crediting you as a trader with leverage.

Unlike the forex market, which operates around the clock, the stock market has specific opening and closing hours. These hours are determined by the opening hours of the respective stock exchange (usually 8 hours on weekdays) where trading takes place. If you use the Internet to trade on the stock exchange and you are not in the same time zone as the stock exchange, it makes trading more inconvenient. The hours of operation of the stock exchange may fall during night time in your area, forcing you to have a night life. Therefore, in the forex market, due to the round-the-clock operation, you have more trading opportunities.

To be successful in the stock market, it is not enough to use the analysis mechanisms inherent in the Forex currency market. Technical analysis and fundamental analysis can be used to predict changes in stock prices, but microeconomic factors affecting a company’s performance are also important. To make the right decision to buy/sell shares, you need access to financial statements, information about personnel changes in the company, government orders for its products. If we are talking about foreign companies, such information is available only from foreign sources: television, newspapers, magazines, the very published financial statements. Naturally, such information is published in a foreign language, which brings significant difficulties in its study and understanding.

It should be said that unlike financial instruments on Forex, the considered financial instruments of the stock market have their own advantages. These are receiving dividends on shares and the opportunity to participate in the management of the company, redemption of government securities, coupon payments on bonds. These advantages partially reduce the risk of losses when working in the stock market.

In this chapter, we have tried to make a comparison between the Forex currency market and the stock market. We have found that each has its own advantages and disadvantages, each is attractive to investors in its own way. In the next chapter we will look at the correlation (interconnection) of these markets and understand how predicting one market can help in making buy/sell decisions on the other.