Are Stocks or Real Estate Better than Forex?
Sometimes Forex trading is deemed subpar, or less important than other asset classes. “The smartest traders are the bond traders,” some people say. Is this true? We think not.
Forex can allow for very tight risk control, especially when compared to stocks or real estate for example. Forex allows you to learn how to trade, risking as little as $50 in some cases. The ease of access makes it an ideal “gym” for training your trading skills, in a very dynamic market. Real Estate (even if via REITs) and Stocks are more complex, and also require much higher amounts of starting capital – which most traders just don't have. Let's explore the advantages of Forex trading more closely.
Forex: increasing popularity
Firstly, a dive into factual evidence. Retail FX volumes, as measured by Leaprate (so an independent observer) jumped 9% in June, driven by Brexit volatility. It’s a fact that through Forex, bullish or bearish markets can be traded equally well. With Stocks, it’s always negative when the markets turn bearish. What this means is that currency traders are very much attracted to event volatility, so negative events don’t shock the market as much.
And if that’s not evidence enough, we can also explore a more influential source: the Bank of International Settlements (BIS) Triennial FX Survey 2013 (the 2016 Survey is under way, but it will take time before it is published).
For the first time, the 2013 FX survey included statistics of retail volumes, and measured primary dealer volumes with retail driven counterparties. The survey indicated that $185 billion, or 3.5% of the total $5.3 trillion total turnover, was retail flow. Of the $185 billion, $78 billion was registered as FX spot, with a slightly smaller amount ($74 billion) in FX swaps. The sole fact that BIS has started to monitor retail trends in FX is evidence of the growing popularity of FX trading.
Why we think FX Trading has become so popular:
- Low complexity: the Major currency pairs (EURUSD, GBPUSD, USDJPY, AUDUSD, USDCAD, USDCHF, EURJPY, EURGBP) account for over 70% of total volume traded. Compare this to the top eight stocks of the S&P500, which account for more or less 20% of total trading volume! There are thousands of stocks quoted on exchanges around the world. Most of these stocks are followed and analysed by specialists within Investment Banks and Funds. If we’re talking about a level playing field, stocks don’t really fit the bill. Compare that complexity to only a handful of major pairs on FX, and another handful of frequently traded cross rates.
- High liquidity/lower transaction costs: the FX market has about 1000 times the liquidity of the S&P500 ($5.3 Trillion ca. vs. $3.5 Billion ca.)
- Lower Volatility: the largest move in recent Foreign Exchange history (GBPUSD on Brexit Day) was 10%. And that’s an enormous move in FX, but for a stock, that’s nothing spectacular. Stocks are much more volatile, and that means potentially higher risk than FX trading.
- Trade anytime: the FX market is open 24 hours a day, 5 days a week. This means that whether you are based in Auckland, Sydney, Tokyo, Singapore, Moscow, Berlin, Milan, London, New York or even Hawaii, all you need to do is turn on your computer and the market will be active.
- Outright fascinating: a Foreign Exchange trader is truly a global-macro trader. What is the impact of an earthquake in New Zealand on the Yen? These are the kinds of questions that Forex traders solve each day.
Forex vs. Currency Futures vs. Stocks
One of the main advantages of forex trading becomes clear when comparing Spot Forex to Forex Futures on the Chicago Mercantile Exchange. Trading futures is much more expensive than trading spot. It's not realistic to trade futures (even mini or micro size) with 1000 USD or less. A realistic starting account should be around USD 10,000 – also because micro-lots are not available on the CME. The smallest trade size is a Mini-Lot (10K).
Above and beyond the starting account size, there is also the commission structure to consider. Trading Forex Spot is much cheaper than trading Futures. If you trade 1 mini-lot ($10,000) EUR/USD on the spot market, you’re only paying a tight spread and a small commission, which, on the majors, can even be lower than 1 pip. Instead, to buy a micro Futures contract (the CME equivalent), there is a higher commission to pay, as well as the spread. But even if on the major pairs the difference can be negligible, there is still an enormous advantage when trading currency cross rates – some of which are not even quoted on the CME.
But the efficiency of Forex Trading becomes clearer if compared with Stock trading. First of all, if you want to learn how to trade and have a small amount of risk capital (say $1,000), some firms won't allow you to open an account. Also, every time you buy or sell stock, you need to pay commissions. Commissions range from the low end of $10 per trade – which is substantially higher than trading fees in FX.
Now, imagine that you decide to buy the stocks of five companies for diversification benefits. To do this, you will potentially spend $50 in trading costs, which is equivalent to 5% of your $1,000. This represents a 5% loss, which puts you at a decisive disadvantage from the start. But it gets worse. If you were to sell these five stocks, you would once again need to pay the commission, which would be another $50. To make the round trip (buying and selling) on these five stocks, it would cost you $100, or 10% of your initial deposit amount of $1,000. You need to make 10% just to break even! It’s not possible to make 10% consistently on every trade, so this inevitably means stock trading with small account balances is a negative sum game.
Spot Forex vs. Real Estate
If we really want to highlight the flexibility that Spot Forex can offer traders, all we need to do is compare it to Real Estate, another alternative asset class. I think we’re all familiar with real estate up to a certain point. We have all played Monopoly at least once in our lives, and we know how painful it is to land on a property with a big Hotel built on it!
The first exposure to Real Estate investing we usually have as kids: Monopoly!
Also, books like Rich Dad, Poor Dad by Robert Kiyosaki have introduced real estate investing to the average Joe. However, each person’s personal objectives and possibilities should be taken into account when comparing potential investment solutions.
Evidently, the main difference between Real Estate and Forex is the capital requirement. Buying property is expensive, even if you get it from foreclosure deals. It’s also a lot more complicated than stocks or bonds, not to mention much less liquid.
Property may be a viable solution if you are looking for passive income, and you have the financial means to go down that road. Also, if you decide to become a landlord, and take out a mortgage in order to buy & rent a property, you remain responsible for paying taxes and maintenance costs. Hence, quite a few years are necessary before this investment bears fruit. And there’s always the extra hassle of finding “adequate” tenants that don’t damage the property...as well as the risk of not finding tenants at all!
When you buy a stock (or if you buy EUR/USD), it sits in your brokerage account and you have no worries other than market risk. With real estate, you might have sudden leaks, the furnace may stop working, etc.
To solve these issues, REITs were born. A real estate investment trust (REIT) is created when a corporation uses investors’ capital to purchase and operate income properties. The advantage is that you don’t have to be the direct landlord, and there is better liquidity since REITs are traded on major exchanges.
However, REITs or REIT ETFs still require larger amounts of risk capital than the average retail investor possesses. And this leads us to the second consideration: with REITs, we’re already on a totally different path compared to traditional property investment. With REITs, we’re talking about capital gains…which is much more similar to spot Forex and, hence, Forex might be the easier solution.
Finally, understanding currency transactions can be easier than understanding the differences between houses. Each property is truly unique, and properly assessing the value of a property is much more challenging. In brief, it requires specialist knowledge. But if you have the time and energy to become a specialist in Real Estate, surely you can do the same and more in Forex?
Over to You
Forex trading is most definitely a low-cost/high-reward market to cut your teeth on. Even better, it's not correlated with traditional asset classes like stocks and bonds.
Even if you have the capital availability to trade stocks or dabble in Real Estate, you cannot possibly be consistent and come out ahead without common sense and a solid appreciation for risk. A solid system is required in any case, to tackle the market’s movements and not enter randomly. Risk management will help you avoid the pitfalls of excessive leverage.
So, don’t follow the herd: act based on your own personal objectives. Forex can be a great way to learn the skillset required to survive (initially) and thrive (eventually) in the financial markets. It’s not a substitute for Stocks or Real Estate, which are complimentary asset classes, but it is a unique alternative asset class that gives you access to the kind of leverage that – if used wisely – can grow your account with very little start-up capital.
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