Since the early years of this century when the forex market has become accessible to every individual investor, many retail traders wonder whether they should trade forex, or perhaps stock indices. Deciding which of the two markets you should trade can be complicated, and there are various factors that you need to consider before making a decision.
This article will help you understand better the similarities and differences between trading stock indices and trading FX currency pairs and choose that asset class that suits your personality, trading strategy, and trading style.
Key Points to Take Away
- Trading indices and trading forex are two of the most popular forms of trading.
- The key differences between stock index trading and trading forex pairs are the way a trader needs to analyze the markets, the leverage ratio provided by brokerage firms, the range of assets, and volatility.
- While forex trading is more suited for active day traders, indices trading generally works best for medium and long-term investors.
First, What’s the Difference Between Trading Indices and Forex?
To begin with, both the forex and the stock markets are among the most liquid financial markets in the world and are extremely popular among short-term traders. This is partly because there’s plenty of news and information when trading one of these two markets, and it is, therefore, easier to take a large number of trades in a short period of time. Beyond that, both markets are very liquid, which is an essential factor for beginner traders who always need a buyer or a seller on the other side of the trade.
The key difference between these two asset classes is that when trading forex, you essentially buy one currency and sell the other, meaning you usually need to analyze two economies. In other words, you need to be aware of the interest rates of each currency, the economic performance of the country as a whole, and the expectations of a rate hike rate cut.
On the other hand, trading major indices typically require you to focus on one market, one economy, and the assets (companies) that the stock market index is composed of. This Is because a stock index is not traded versus other assets and generally has an upward bias due to the nature of the stock markets. Consequently, it would be fair to say that stock indices are generally more suited for long-term investors or medium-term traders.
What’s more? Index trading typically has wider spreads, which makes it, once again, less suited for active day trading, or scalping. When you trade stock indices, it is a challenge to make intraday profits due to the relatively high spread charged by brokers, the low leverage, and the low volatility (when compared to stocks and forex currency pairs). As such, most people who trade indices usually focus on swing trading (holding poisons between 2-5 days). As for forex – some brokers offer zero spread on FX currency pairs so with the combination of high leverage and very low trading commissions – the forex markets are the ideal playground for active day traders.
Leverage in trading is known as a double-edged sword – It increases the potential of making profits but also the risk of losing money rapidly
Trading Indices vs Forex – Which Market is Better for Beginners?
Beginner traders and those who prefer simplicity generally will choose to trade indices. With stock indices, trading is very simple and straightforward. After all, almost every person on the planet has some basic understanding of the stock markets, and thus, analyzing stock indices requires a less tactical approach and in-depth knowledge.
The forex market, on the other hand, is more complex. Investors who want to start trading forex need to learn the basics of the forex market and understand what forex is and how it works.
Nonetheless, when it comes to choosing which is the best market for you to trade, there is no decisive answer to this question. Each market has its own pros and cons and there’s no reason for you to not take advantage of both markets, especially if the broker gives you access to both of them.
What are the Possible Ways to Trade Indices and Forex?
One thing you should note: stock indices are not traded on a stock exchange. They are simply benchmarks that track a list of stocks on a certain exchange and are used to measure the growth of the general stock markets. What it means is that, unlike trading stocks, the only way to trade indices is via futures contracts or via CFDs (Contract for Differences). For those unaware, CFDs are financial derivatives that enable traders to speculate on the market movement of assets without owning the underlying assets.
Trading forex is more accessible to ordinary people and there are several ways for any individual to speculate on the price movement of currency pairs. These include the spot market (via bank or a forex change store), futures, and trading CFDs.
Indices vs Forex – Number of Available Markets and Instruments
A crucial factor to consider when choosing an asset class to trade is the range of assets available on each market. When comparing indices to forex, trading the forex market clearly offers more markets and instruments than trading stock market indices.
Whether you decide to start trading indices via stock index futures contracts or via CFDs, typically you’ll get a range of 15-20 assets. On the other hand, every CFD and forex broker usually offers a range of at least 30 currency pairs, with some brokers like Switch Markets offering a higher selection of 60+ FX pairs.
For various reasons, forex traders typically focus on major currency pairs that include the EUR/USD, GBP/USD, USD/JPY, USD/CAD, AUD/USD, NZD/USD, and USD/CHF). These pairs are the most popular and liquid assets and are widely covered in the media. Additionally, most forex brokers offer very high leverage for major currency pairs and very tight spread – another incentive for traders. Some traders, however, prefer to stick with exotic currency pairs, largely due to extreme price movements and the high volatility.
So, all in all, when compared to indices, the forex market offers a larger variety of assets (at least 100+ assets).
On another note, a useful tool that can assist you in analyzing currency pairs and stock indices is our market heap map that highlights the daily strengths and weaknesses of different assets.
Forex Trading vs Indices Trading – Key Similarities and Differences
Below, we break down the key similarities and differences between trading forex and indices.
Liquidity – Both markets are extremely liquid, offering investors to get market execution at any given moment.
Both Rely on Macroeconomic News – One of the key similarities between indices and the forex markets is the way you need to follow market news and economic data. Unlike stock trading which requires you to spend time on picking and analyzing public-traded companies, trading indices and foreign exchange currency pairs are based on macroeconomic factors and the economic state of countries.
Market Trading Hours – Even though the stock markets are open for a limited time during the day, nowadays you can trade indices futures or index CFDs 24 hours 5 days a week, much like the forex market.
Analyzing the Markets – As we mentioned before, the way a trader analyses the forex market and stock indices is a bit different. This is because stock indices are a collection of top-performing stocks and do not trade against another financial instrument. Hence, a trader needs to analyze the economic performance of the country and be aware of any developments in the companies that composed the index. When analyzing currency pairs, a trader must have more macroeconomic knowledge and be aware of the factors that affect the price movements of forex pairs one versus the other.
Leverage Ratio – Assuming you decide to trade one of these asset classes via a CFD broker like Switch Markets, then you’ll be able to use the leverage that gives you the option to trade with higher capital than initially deposited. In this case, the leverage provided for forex tends to be much higher than indices and other markets. On most CFD platforms, traders generally have access to 30:1 for currency pairs and 20:1 for indices. That said, some CFD brokers like Switch Markets provide a higher leverage ratio for FX currency pairs that could be as high as 500:1.
Range of Assets – Usually, regardless of the trading platform you are going to choose you’ll be able to get access to 10-15 most traded indices. On the other hand, if trading forex, you get access to at least 30 FX currency pairs, and some brokers even offer a larger selection of 100+ currency pairs.
Volatility – Forex has the lowest volatility of all markets, partly because currency pairs have a major role in civilians’ income and in a country’s economic performance.
Price Gaps – Because the forex market is open 24 hours a day five days a week, price gaps are less common in the forex market than in indices.
|Forex Trading||Indices Trading|
|Best For||Active day trading||Medium and long term investors|
|Range of Assets||On most trading platforms – 50+ currency pairs||On most trading platforms – around 10-15 stock indices|
|Leverage Ratio via CFDs||Usually between 30:1 to 500:1||Usually around 20:1|
|How to Trade||Spot, futures, and CFDs||Futures and CFDs|
To trade indices, investors need more capital than they do with forex. On the other hand side of the coin, trading indices are presumably less risky due to the lower leverage ratio provided by brokerage firms.
The bottom line, index or forex trading will serve your purpose to be able to place a large number of orders on a trading day and find lots of trading opportunities. Both markets are liquid and volatile enough and the flow of news and analysis will help you form your own trading plan and strategy.
Ultimately, I still think the best way to make an informed decision on the asset class you want to focus on is to try both markets and see where you feel more comfortable. Even today, very often I switch between markets with the intention of finding the right trade. You should do the same, at least at the beginning of your trading journey. Luckily, some CFD brokers offer you to open a trading account (or a demo practice account) where you get access to a number of markets including, obviously, the forex market and stock indices.
Well, that is a matter of opinion. Trading is subjective and every trader feels more comfortable in other markets. Some prefer to trade the volatile crypto jungle while others prefer to trade less volatile assets like fixed-income assets.
Still, while many people like the flexibility of the forex market, it is known as a riskier market for one primary reason – that is the high leverage provided by forex brokers.
The way I see it, if you choose the right platform then you should try to have the best of both markets. Financial markets like the forex markets and indices are connected beyond generic correlations, which means you can follow all markets and find trading opportunities in any market you have access to.
Some of the most popular and widely traded stock indices around the world include the S&P 500, NASDAQ100, Dow Jones Industrial Average 30, Nikkei 225, FTSE 100, CAC 40, and DAX 40.
In normal market conditions, stock indices and the forex market don’t have a high correlation. Also, each stock index has a different relationship with its domestic currency, which means every case has to be assessed differently. That said, all markets are interconnected so there’s certainly a connection between stock indices and currencies – In most periods when the domestic stock market index rises, the local currency tends to strengthen and vice versa.