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Tuesday, January 1, 2013

Trading Forex vs Stocks. Which one offers better chances of long term profitability?

Controversial topic indeed and I'm going to offer my point of view based on my limited experience of 3 years and the knowledge I've been able to gather while intensively studying both markets.

First, the game is extremely difficult in both cases. With most people always throwing a number between 90% to 95% of traders losing money. I haven't found hard evidence supporting these numbers. And by hard evidence I mean statistical studies with reliable sources showing numbers backing up that claim. But, I also find no reason to not believe it. In fact most clues do reflect that, clearly, the vast majority of traders lose money.

At the same time there is also potential for massive returns in both. And I'm in no position to question which one can yield better returns. I would say, it is possible (at least theoretically) to obtain massive returns in both.

What I wondered as a newbie trader was which one offers the better chances for long term profitability?

In Forex you have a much higher leverage. Where you can artificially multiply your bets by 50, 100, even 500 with some brokers. But leverage is a double edge sword and it also works against you. So, I don't count that factor as an advantage.

Forex is a 24 hour market. And many list that as an advantage over stocks. Now my personal experience tells me that fact doesn't provide any additional edge as a Forex trader. If anything, it is something negative for a trader, who, as a human needs to sleep while the show goes on.

There is better liquidity in Forex. No question about that. Orders get almost instantly executed without too much hassle unlike stocks. That could offer some slight advantage to a Forex trader who could potentially always enter his trades and apply his strategies 100% of the time.

Trading costs. Tighter spreads in Forex make it less costly to trade. Forex wins this aspect, no question about it in my mind.

However, the Forex market is a more efficient market. Meaning, the huge volume that is traded every day, makes it almost impossible for anyone to manipulate a currency (Except of course national banks with their monetary policies). More efficient markets are harder to predict. Plus the fundamental factors affecting the value of a currency in the world can be counted in the hundreds. How many factors can be affecting the value of the Euro at any given moment? Versus how many factors can be affecting the value of Home Depot? I believe taking all possible factors into account for a currency analysis is near to impossible.

Stocks can be manipulated, in fact they are every single day. There is less volume, in general, so the big orders have more of an impact and predictable power, and they are also trackable due to the nature of stocks markets being centralized vs the Open/Non-centralized/Non-regulated nature of the Forex markets.

Forex is a zero sum game. Your profits come at the expense of someone else's loses. No value is added or created. Stocks on the other hand have at least a positive long term bias. With the market value usually growing somewhere around 7% per year on average. Investors put their money on companies that can potentially improve their business, create more value and they get appreciated as a result of usually higher earnings. There are bear markets, yes there are, but the historical nature of the stocks market shows an unquestionable uptrend bias. Plus stocks have the added benefit of the dividend. Just being an investor gives you the right to get a piece of the earnings of the company you hold, which can be 3% per year, but it can also be 7% per year. In any case it is an added benefit.

Due to those reasons, I believe trading stocks offers better chances for long term profitability. Which makes me wonder "What the hell I'm I doing trading Forex?" Well, I guess the massive amount of participants across the globe make it an attraction for me. Plus it is a tougher challenge, given the smaller odds of being successful. I think the masochist side of me also enjoys a part of that.

I hope you enjoyed this article, and of course you are welcome to disagree.

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