what the about the stock market?

Pipruit: Sir, I still have some concerns. Yes, we’ve investigated and seen that the FOREX market is the most liquid and huge and is the best of the best, etc. But, the majority time on TV financial news is about stock markets and other stuff that is linked with stocks. Is it correct to compare these markets from the trading point of view?

what the about the stock market?

Commander in Pips: Not quite, because these markets have absolutely different purposes, this is almost the same as compare fish advantages to bird advantages. But during recent times some myths have appeared concerning FOREX and Stock market comparison. Besides these, there are some points that could be used in comparison, because they are common for any trading market. These things have nothing to do with the nature of particular market, but refer to technical issues of market functioning. I mean timing, fees and other things.

Pipruit: Well, this should be even more interesting than I thought.

Commander in Pips: I hope you’re right, so let’s get started on Stock vs. FOREX myths to find the truth…

MYTH #1 The FOREX market is simpler, because the stock market includes about 8000 stocks (NASDAQ and NYSE listing together), and it is difficult to decide, which one should be traded.

Neither true nor false

This is an excellent example of confusing market purposes. First of all, to own a stock is a quite different than to own a currency. Owning a stock gives you the rights of participation in company governance and on a share in its income. Owning the currency is quite a different thing.

And what if you do not intend to hold any stock or currency for a long time and your target is just a speculative income. That’s ok - from trading perspectives and speculative approach to trading, there is no difference which stock to trade, because the major condition for speculating is liquidity. Take any share of a large company (so-called blue chips) and you will almost always have sufficient liquidity for speculation. If you do not know yet what stock to choose – that’s fine you can trade the whole stock market with stock indexes futures, like an S&P500 that includes 500 most large companies or Dow Jones. Or you can buy shares of index mutual fund, or even an ETF that specialized on stock markets.

MYTH #2 The FOREX market is much less influenced by analytics opinion than stock market.

True

In fact, this is an old story, when well-known analyst of large brokerage company gives some recommendation on some stock that is not necessary the real their opinion. This is a big game of big men and the investing public is just a puppet in their hands. You can easily find these facts in the history, when large brokerage firms had held “Buy” recommendation on shares that were falling like a stone. I give you just one example for what this could be done, but there are others also. This brokerage firm has an order for selling the large number of these shares from a big client, or may be this firm itself has a large number of shares and they had already started to sell them off gradually, so they need to hold the price as high as possible.
Current law has a basis for punishing these abuses currently and although the government tries to control these facts and punish for price manipulation, it’s very difficult to prove it. And in spite of any punishment procedures this happens again and again, because the risk/reward ratio for these companies usually is very large.
There is couple of things that make this possible. First, stock analysis is not simple task to do and a very small number of individuals really do it by themselves. You have to be confident in fundamental analysis, math, valuation and book-keeping to do it. This kind of work demands a lot of time. Usually, the public buys some internet bulletins or something like that and it leads to the possibility of influencing public opinion by large brokerage companies. Second, 5% of shares of overall free float is a big amount. Shares spread widely between lots of participants, that’s why if somebody with large amount of shares intends to buy or sell, it could be a big influence on market behavior.

MYTH #3 The FOREX market can’t be ruled by large participants, at least in the long-term

True

We’ve talked about it already in previous chapter. Even central banks can’t move FX market prices at will for an extended period of time. Yes, a Central Bank can initiate a strong, short-term move with currency intervention, but can’t hold it too long because of the huge trading volume.
In opposition to the FOREX market, the stock market is very sensitive to the buying and selling big amount of shares by anyone, for example, large mutual fund. Even rumors can lead to strong movement in price.


MYTH #4 FOREX does not have any middlemen, and stock market has a lot.
MYTH #5 FOREX has no commissions or they much lower than on stock market.

Both True

But I prefer to say that in a bit other way. Middlemen on FOREX are greatly cheaper than on the stock market. The stock market has some types of fees not seen in the FX market. Because the stock market is exchange traded market, the Exchange itself collects fees from client’s turnover. You can pay only these exchange fees if you will buy an exchange membership. But it’s very expensive, for example, according to NYSE data, the cost of membership in 1999 fluctuated between $2mln and $2.65mln. That’s why most individuals trade stocks via different brokerage companies. But the price for that is an additional brokerage fee. Besides the exchange fee and brokerage fee, some brokers have a custodian fee. This fee is for booking and servicing your shares packs (for example, servicing such procedures as splitting of shares, dividends payout, or just for keeping them, etc). The amount of fees and commissions vary amongst the brokers and depends from some factors, such as full-service broker vs. discount broker, your assets value and turnover etc. But average brokerage fees are between 0.19-0.35$ per share. For example if you buy 100 Google shares for $500 per share and sell for $501, you will get profit of $100 but pay a fees between $38-70 (because of fee demands for both part of trade – buying and selling). Of cause, may be if you will show large turnover, your fees will become lower, but even 0.05$ per share is not very cheap.

On the FOREX market, there is a quite different story. Although I think that retail brokers are still middlemen between public and large banks, in the majority cases your expenses are just built into the bid/ask spread and not any additional fees. Due to the extremely high level of competition between FX retail brokers, this spread has gradually become tighter. Now it’s about 0.0002-0.0005 (2-5 pips) in quotes for major pairs. If, for example, current EUR/USD quote is 1.3050, then even 0.0005 spread is just a 0.04%! The highest spread, i.e. expenditures on the FOREX market are at least 2-2.5 times less than the lowest expenditures on stock market.

MYTH #6 FOREX is 24-hour market but stock market is not.

True

We’ve talked about it already in previous chapter. NYSE, for example has strict trading session time, that starts in 8:30 Chicago time and closes at 15:00. There are some limited ways to trade stocks after hours, but these have issues with liquidity.

MYTH #7 Market Orders on FOREX have Instant Execution.

Partially True

I’m not totally agreeing with this, because there is a major difference between trading shares and FOREX. When you are buying or selling even single stock, your order is transferred by the broker to the exchange directly, and after your transaction, the shares really change their owner. This procedure demands time, and during non-normal trading environment (for example during some breaking news release) the filling of orders when their flow to exchange becomes really big, can lead to slippage and delay in execution.

On the FOREX market, the situation is a bit different. First of all, it’s much bigger, so there is a much greater flow of orders needed to lead to slippage in execution. It means that simple individual may do not see any skewing delay or spread widening in quotes, but some bank that trades with large bank definitely will see it. Second, not every transaction that is made by individual is transferred to the real market and leads to direct currency exchange. The conclusion is as follows – FOREX also has slippage, delays in quoting and widening of spread, but usually when trading volumes are really big and on transactions that are made directly on the market with real currency delivery. These divergences may not have impact on public, but sometimes they do, when the trading environment is strongly stressed. But anyway this happens much rarely than with the stock market, as long as you have a good forex broker and a fast internet connection.


MYTH #8 FOREX has no restrictions on short selling.

True

The stock market has some restrictions on short-selling stocks. Sometimes short selling could be forbidden by regulating authorities and/or the exchange itself, for example, during a financial crisis or some strong geopolitical events, such as awar starting or terrorist attacks. Also most exchanges have limitations for price movements of stocks in one direction during a day. If this limit is reached, the exchange can interrupt trading for some time. The FOREX market does not have all these restrictions, because, as we already know, during transactions one currency is buying but another always selling, so there is no big structural difference in whether you short or long on particular pair. You may do what you want, at least as long as you can find a counterparty for your trade on the market. But as we’ve investigated before, there are few problems on the FOREX market with that due to extremely high liquidity.

MYTH #9 All FOREX brokers have the same quotes and charts, just like stock brokers.

False

In fact, on the FOREX market, quotes at the same moment of time can be different with different brokers, but should be close if they are really connected to large banks. Moreover, the charts of price action that brokers provide depend on broker’s time zone location. Because FOREX is 24-hour market and the stream of quotes never stops (except on the weekend), the start of the chart for the current day, for example in Japan and in UK, can be different. This makes technical analysis on the FOREX market using daily charts a bit tricky.

On the stock market all brokers have the same quotes at the same time, because they are transferred from the exchange (NYSE for example) directly. Even more, you can check every tick that happened during the trading session, because all trades fix and write in the exchange database. This leads to particular nuance that is very important. For example, on the stock market if your stop order has been hit and there is no such price in the exchange’s database, you can file a lawsuit against your broker and you should easily win. Alternatively your stop order execution should be canceled in this case. On the FOREX market you can’t do this, because it has no absolute center of quoting. This is just a community and every member can generate his own quotes. This can lead to some difference in quoting with different brokers. And there is no way to prove which price is truly had place on the market at particular period of time and which one had not.

MYTH #10 The safety of assets and trading procedure on the FOREX market and the Stock market are the same

False

The major difference between stock market and FOREX is application of segregated trading accounts on the former and their absence on the latter. A segregate account is an account only for a client’s trading assets that is separated from the assets of the brokerage firm. A brokerage firm can only use these assets due to a client’s orders and in favor of the client. It can’t use them for their own interests. What does it mean for ordinary client? It means, that if a stock brokerage firm will fall under bankruptcy or meet some financial difficulties, the client’s assets will be untouched and in safe. Personally, I’ve seen this event during REFCO forex brokerage bankruptcy procedure. Other people who have traded on the FOREX market have lost all or part of their money in cases like this. On over-the counter markets, client’s assets are transferred to the account of the broker. This is also typical for the bond market that is also an over-the-counter one. Some FOREX brokers claim to keep client money in segregated accounts. Demand to see proof of this before believing such claims.
Also, there is an insurance pool for client’s stock brokerage accounts in existence with $15 million in assets on average. So, stock trading accounts have much stronger safety than FOREX accounts.

MYTH #11 FOREX market and Stock market are both highly regulated by government authorities.

False

This statement is not correct for some reasons. First, the stock market is highly regulated by the exchange itself. Second, the US stock markets are highly regulated by the SEC (Securities and Exchange Commission). It is a government authority which has the major purpose of monitoring the appropriate functioning of the stock market with a priority on the interests of ordinary investors. The SEC also has strict rules for stock brokerage companies – minimum capital, licensing etc. In general it is not a simple task to become a brokerage company on the stock market.

On the FOREX market rather, brokerage companies have no particular regulation, except for national laws and regulators. Most US FX Brokers become a member of NFA (National Futures Association). We will talk about in the next part, but until recently, they didn’t have a full legal obligation to join the NFA or any regulator. In general, a FOREX broker is just a financial company that can meet with ordinary financial problems and other unwelcome moments that can in general could happen with any financial company. So, despite of any loud scandals and law processes with stock brokers, in general, the stock market is regulated much more strongly than FOREX.

At the end of this conversation I just specify the additional points that we’ve discussed already and that the FOREX market has and the Stock market does not:
1. FOREX has no definite and strictly determined lot size – the lot size on stock market is specified by exchange rules;
2. On the FOREX market, applied leverage that can reach as high as 500:1. In the stock market due to legislative rules, you usually can’t get more than 2:1
3. FOREX has very low demand for start-up assets due to variable lot size and high leverage. The stock market typically demands greater assets for starting up a trading account.
4. FOREX brokers provide clients with free “demo” software with real market quotes that could often be used for an unlimited period of time. Stock brokers also sometimes do this, but usually only for a short period since exchange quoting costs.

Pipruit: Well, thanks Commander. Now it looks less obvious than before. The FOREX market looks simpler, cheaper and more available from a trading perspective. But the stock market is safer, although it’s more expensive. Also I understand that this kind of comparison makes sense only in terms of trading procedure and technical issues of market functioning. Not from market purposes. Because the major purpose of stock market is raising capital for private companies and the purpose of FOREX is currency changing.

Commander in Pips: You’re absolutely right about that comparison. You’re welcome. So let’s make some conclusions about couple of these different markets:

Quality	Stock market	FOREX market
24/5 market	NO	YES
Absence of fees and commissions	NO	YES (many brokers)
High leverage	NO	YES
Expensive middlemen	YES	NO
High entry barriers (initial assets)	YES	NO
Free demo software for unlimited period of time	NO	YES (many brokers)
Highly influenced by analyst opinion	YES	NO
Could be driven by a large participant	YES	NO
Stronger limitations on short selling	YES	NO
Faster order execution and rarer slippage and delay	NO	YES
All brokers have the same quotes	YES	NO (but usually close)
Higher asset safety	YES	NO
Higher government regulation	YES	NO