Today’s article examines the differences between forex and stocks.

The primary function for stocks is to invest in the future of companies that you believe are going to grow over time. “Investing” implies long-term commitment to a company and its vision, in the hope that the money you put into the investment will grow along with the company.

The goal with stocks is to grow your wealth over time by investing in the success of others.

Forex is short for “foreign exchange”, which refers to buying and selling international currencies in the hope of currencies becoming more valuable when turned back into dollars.

The exchange rate between US dollars and other currencies are constantly in flux, as are the exchange rates between international currencies.

Thus, forex is a means of speculating on the rise and fall of other currencies in relation to the currency of the speculator’s home country.

When it comes to forex vs. stocks, stocks have a positive expectation over time.

Forex is more like gambling.

What are stocks?

When you purchase stock in a public firm, you own a piece of that firm. Most likely, you chose to purchase that stock because you have decided that, over the long-term, the stock’s value will grow as the company’s intrinsic value grows.

A stock’s trading price at any moment in time depends on the supply and demand of the stock itself. As demand increases, so does the stock price, and vice-versa.

What is forex?

With forex vs. stocks, it is the foreign exchange market where currencies are traded.

Why is there an exchange market? Because currencies must be exchanged to conduct trade and business in other countries. If you live in the UK, and want to buy pasta from Italy, either you or the company that you buy the pasta from must pay the Italians for the pasta in euros.

Thus, the UK buyer must exchange the equivalent value of UK pounds into euros.

If you’ve ever visited a foreign country, you had to engage in currency exchange. You can’t buy anything in Hungary unless you exchange your US dollars for Hungarian Forint.

However, currencies can also be used as a trading vehicle to profit from.

Let’s say one US dollar buys one Canadian dollar. You use 100 US dollars and buy 100 Canadian dollars. Over time, due to various factors, the market shifts and you can only get 0.9 Canadian dollars for each US dollar.

Well, that’s great for you! Since you have 100 Canadian dollars, you can exchange those 100 Canadian dollars into $111.11. You’ve made an 11.11% profit.

Read Also: What are the best tech stocks to buy right now?

What are the differences between forex and stocks?

The best way to think about forex vs. stocks is that forex are a form of short-term speculation that’s really no different than gambling, whereas stocks are designed to be owned and held for the long term.

With this distinction also comes limitations on profits in forex, primarily because how the markets are structured.

With stocks, you can invest in them, hold for the long term, and have a good chance that over a long period of time, they will appreciate in price. The price appreciation can be quite significant over that period – multiples of your original investment.

The only costs associated with this approach are very small trading fees when you buy and sell, and the taxes on any gains you’ve made if you sell the stock.

Forex is a different beast. There’s a high volume of trading that occurs in forex, and currencies do not fluctuate very much in most developed countries.

Look at this chart. When the euro debuted in 1999, one US dollar was worth 1.1553 euros. Today, one US dollar is worth 1.1318 euros. If you had purchased euros in 1999 and held them, your position would declined about 2% in value.

Here’s a chart of the S&P 500 from those same dates. If you bought and held that index, you would have made 116% on your money.

That’s the biggest difference between forex vs. stocks.

Now, if you were very savvy and managed to catch all the highs and lows of the euro market over the past twenty years, maybe you would have caught some of the bigger moves. But nobody is that savvy.

Advantages of Stocks

 

When it comes to selecting forex vs. stocks, here are the advantages of stocks:

1. Long term history of profit
2. You can also bet against the market
3. Dividend payments

Here’s a video that gives additional information on investing in stocks, from one of the greatest fund managers in history, Peter Lynch.

Long term history of profit

If you look at any 10-year rolling period of the Dow Jones Industrial Average, you will see that — except in 1929 – the DJIA never lost money.

If you look at any 20-year rolling period of the Dow Jones Industrial Average, you will see that the DJIA only had two years in which its returns were negative (1932 and 1949).

If you look at any 35-year rolling period of the Dow Jones Industrial Average, you will see that the DJIA not only never lost money, but never made less than 6%.

There’s a reason for this performance. Capitalism produces wealth. Companies that make goods and services that solve problems make money. That money gets invested into the business and it grows. As it grows, its earnings grow, and as its earnings grow, its stock price increases.

Forex does not have this kind of performance.

Bet against the market

We spend a lot of time at InvestingDaily.com talking about buying stocks for the long term. But there’s another strategy called “short-selling”, in which you effectively bet that a stock or entire indices will go down instead of up.

Indeed, if you look at any chart of any company or index, you will find periods in which they have gone down.

The advantage of stocks is that you can invest in individual companies that you believe will do very well in the long run, and sell short the stocks of competitors that you believe will fail, or even of entire indices if you think the broad market isn’t as resilient as those individual stocks you like.

You can even buy an entire index because you expect it to go up over the very long term, and sell short the stocks of companies you believe will fail.

Dividend payments

One of the great advantages in regards to forex vs. stocks, is that some stocks make regular dividend payments.

If the cash flow for a company is very strong, and it is able to use that cash to meet expenses, to grow, to contribute to employee pensions and so on, it may still have money left over on a regular basis.

Many companies choose to give that money back to shareholders as a kind of reward for taking the risk of investing with them.

Forex does not pay dividends.

Advantages of forex

There are a few advantages when it comes to forex vs. stocks, so you shouldn’t dismiss forex outright. Here are some things to think about:

1. Can hedge against multinational stocks
2. Can be a safe haven in bad economic times
3. Many options

Here’s a video that gives basic information on how trade in forex markets.

edge against multinationals

Most of the biggest companies in the world now obtain more than 50% of their profit from overseas. These multinational companies thus do business in many foreign currencies, and not US dollars.

As such, if those currencies are very strong against the US dollar – meaning it takes more and more of those currencies to exchange for a US dollar – then when those companies translate their foreign earnings into US dollars to report to shareholders, the earnings can take a significant hit in our home currency.

The forex market allows you to hedge against those stronger currencies to offset those effects by placing some of your money into currencies that are weaker against the dollar.

Safe haven

When times are bad in the United States, you can theoretically exchange your US dollars for currencies that are weakening against the dollar. It’s rare, but it does happen.

Many options

While the stock market has several thousand securities to choose from, there are only about 180 currencies recognized by the United Nations. Still, that’s a lot to choose from, and if you are really interested in trading currencies, you have many options.

The best currencies to stick to are those in countries that are politically stable. One of the biggest downsides with socialist and communist countries is that the government can do anything it wants with the currency, including devaluing it.

If you are a world traveler or do business in many different countries, you may get a feel for how currency markets operate. Thus, you may have the kind of knowledge most people don’t, and can use that knowledge to profit in the currency markets that you know best.