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#1 06-03-2019 16:24:47

johnedward
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From: Paris - France
Registered: 21-12-2009
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Why professional traders prefer stocks rather than the forex

Why professional traders prefer stocks rather than the forex


Article originally by TopBrokers:

15 September 1992 will forever be remembered as Black Wednesday because it was the day the UK withdrew from the European Exchange Rate Mechanism (ERM). Following the action by the British government, the sterling pound dropped in value drastically, creating some excellent trading opportunities. Among the traders who benefited the most from the action was George Soros, who netted a $1 billion profit from a single trade. This was and still is the highest ever profit recorded in the Forex market on a single trade, giving Soros the title, Ďthe man who broke the Bank of England (BoE). George Soros wasnít the only one who profited from Britainís withdrawal from the ERM, causing a total loss to the British Treasury of 3.4 billion pounds. These are staggering amounts of profit to be made in a single day, and yet most professional traders still prefer to stick to stock markets rather than Forex. Why is that? This is the question we shall be exploring in this post, discovering why these Wall Street sharks are reluctant to enter the Forex market, and whether you should do the same.

Stocks are better than forexÖ a professionalís point of view

In order to understand why many professional traders steer clear from the forex, we have to look at both markets from their perspective. It is only after doing so that we can determine whether they are right to stick to stock markets, and if Forex traders are misguided. The reasons why the pros prefer stocks over currencies can be summed up in 5 sections:

Forex markets are just too damn volatile

Speculators like you and I prefer to trade assets with high liquidity, and the Forex markets provide that. However, professional traders do not like too much volatility, instead preferring less volatile markets like the stock market. To understand why volatility would be unattractive to a professional trader handling billions, itís best to look at an example comparing the EUR/USD live charts to the value of Amazon stock. The first image below represents a weekly chart of the company Amazonís stock price over the past three years. As you can see, the stock price is generally stable and follows a consistent pattern for the most part. In fact, the only change to the upwards trend occurred during the second half of the year 2018. If we were to zoom out even and look at the companyís stock price over the last 9 years or more, the trend would still be similar.

http://www.forex-central.net/forum/userimages/amazonSharePrice.PNG


Now letís look at a chart of the EUR/USD pair over the same period as shown in the image below. Unlike the previous image, we can see that the prices on the forex haven't been as stable as those in the stock market. Clearly, there isnít a single trend occurring over the same time period, but rather the prices fluctuate around a pivot point. For now, letís ignore the trends or lack thereof and focus on the length of the candlesticks as we shall discuss the former in more detail in the next section.

http://www.forex-central.net/forum/userimages/eur-usdPRICE.PNG


The length of the candlestick is important because it shows us the amount of volatility experienced by the asset every week. For the stock market, there was little volatility because the candles remained more or less similar in length. The only times when the candles were longer can be observed when the companyís earnings reports were being announced marked by ĎEí on the chart). Other than that, things were relatively stable. Over on the forex market, things were completely different because the candles would shift in length from one day to the next, indicating a higher level of volatility.

The higher levels in volatility are due to the global nature of the Forex markets compared to stock markets. Sure, anyone can buy a stock from anywhere in the world, but the only factors that affect the stock price are dependent on the company and its operations, mainly in the US. Unlike stocks, currency pairs can be affected by news on the economic calendar coming from anywhere in the world. Moreover, a lot of economic factors for countries are intertwined leading to even more volatility. For example, the recent trade wars between China and the US have affected the values of these countriesí currencies tremendously causing rapid changes in their values. And itís not just these direct confrontations either, as some occurrences like an economic slowdown in China can affect other countriesí economies.

In short, there are a lot of factors a trader must consider when trading Forex markets because all of them affect the value of currencies. On the other hand, it is much easier to predict a stockís performance by analysing the companyís performance. Data such as a companyís earnings, cash flow, returns, net margins, etc. all tell you about a companyís stockís intrinsic value. From these, you just need to find out if the intrinsic value is higher than the current market value and buy or sell accordingly. Perhaps some more information on management and other factors could also be useful as well. With the correct analysis of all these factors, it becomes easy to predict how the stock will perform in future, and this reduces the volatility.

Volatility isnít bad per se, but professional traders would rather avoid too much volatility. When youíre making trades worth millions of dollars, you generally want to avoid any unknowns and only deal with foreseeable facts. As you can see from Amazonís stock price chart above, the price consistently stayed above the 100-week moving average, and this is thanks to minimal volatility. This is probably the main reason why a professional trader would rather stick to stocks and avoid trading currencies. Remember that if a trader loses money, they lose on their yearly bonus, which is very lucrative. So rather than take unnecessary risks, they stick to a less volatile stock market.

Forex markets donít trend for extended periods of time

The same charts we sampled earlier also represent this factor very well Ė stock markets generally trend upwards. Of course, there are some companies whose stocks decrease in value and some are even kicked out of the stock exchanges they were previously listed on. However, for the most part, the stock markets keep trending upwards. The most reliable evidence to represent this fact can be observed on the S&P 500 that includes the values of 500 companies in the US. The graph represents more than a decade of the US stock markets, showing that they have been (generally) on an upward trend. The only exceptions were during such times as the 2008 economic crisis. Indeed, this is why ETFs are so profitable that even Warren Buffet advised people to invest in them rather than buying individual stocks and Ďplayingí the markets.

http://www.forex-central.net/forum/userimages/SP500-chart.PNG


The reasoning here is simple, professional traders prefer to hold long-term trades rather than short-term ones, and the stock market is more suitable for this kind of trader. For an individual like you or I, we probably plan to hold our trades for a day or a week; maybe a couple of weeks at most. Itís not that long-term trading is prohibited, but there are various hindrances. The most obvious one is impatience. Can you imagine watching a single trade on a currency pair for a year? I doubt you can because, at some point, the trade will hit your take-profit target, or you will just reach your desired return and close the position. Why wouldnít you? After all, youíve got to enjoy the fruits of your labour. A professional trader doesnít have this same problem because they have been hired and probably have a weekly or monthly salary. They donít gain anything from closing a position early except more stress in identifying another trading opportunity. Therefore, the stock market is just more ideal for them.

The other problem with position trading is that it requires a lot of capital for it to make sense. Letís say you were to make a typical trade of 0.01 lots because you only have $500 as capital (this is the safest bet considering risk management). Had you shorted the EUR/USD pair at the start of 2018 when the value was around 1.2 and held onto the trade throughout the year until the end when the pair traded at 1.13, you would have only made $60 in profit. For a whole year! Doesnít seem worth it does it? This is why traders usually prefer to become scalpers making even hundreds of trades in a day, which would, in the end, provide a larger profit.

By now you may be wondering, if the problem is the amount of capital, why wouldnít the professionals still trade their huge sums for more profits? Well, once again thereís another limitation Ė forex markets entail extra swap fees while stock markets earn extra profits in dividends. Overnight swaps are charged every night and weekend you keep a position open in the Forex markets. While sometimes the swaps could be positive, they could also be negative, eating away at the profits earned. Contrary to this, stocks attract annual dividends for every stock held, and when you hold enough stock, the amount can be very lucrative. Therefore, these professional traders who hold on to trades for months and even years prefer stocks because they can earn extra money every time the company issues annual dividends.

Add to that, sometimes a stock may be split giving even more stocks to the investor. An often quoted example is that of Netflix, whose IPO in 2002 valued the companyís shares at $15. By 2008, the shares were worth around $29. Had someone purchased $100 worth of shares in 2009 (about 3 shares), their investment would be worth about $7,000 in a decade. This is because the stock split at a ratio of 7:1 in 2015, leaving you with about 21 shares of the company. That is before even accounting for the annual dividends. Now imagine a trader who bought thousands of the companyís shares.

Given that the stock market trades in a definitive trend over a longer period of time, and the additional perks the market provides. It would only make sense for a pro to trade this arena over forex.

There just arenít enough options

The S&P 500 can be misleading in making one believe there are just 500 companies, but in truth there are lots more companies listed on exchanges. The NYSE alone lists about 4,000 companies and a similar number for the Nasdaq exchange. In the US, approximately 14,000 company stocks are traded, although not all of them on major exchanges. Across the globe, about 45,508 companies are listed on various exchanges, which is a huge variety to choose from. Most of these listed companies are not heavily traded, obviously, but they can be traded nonetheless if one wished. Sometimes these obscure companies can even provide more lucrative returns because they are more volatile. One such penny stock was American Axle whose stock depreciated below $1 during the 2008 economic crisis, but it now valued at around $13 per share having reached over $25 in 2015. There are many other similar stories, showing that the huge variety in the stock market can provide plenty of opportunities. 

The Forex market just isnít as robust as the stock market. When you are choosing a Forex broker, you will find the top and most reputable brokers that offer more than 50 currency pairs. Whatís 50 or so compared to 45,508? Additionally, even these 50 or so currency pairs mainly revolve around a single currency Ė the US dollar. According to the Bank for International Settlements, the US dollar was responsible for 87% of all trades in the Forex market. Other dominant currencies include the sterling pound, euro, yen, Swiss franc, Australian dollar and Canadian dollar. Other than these, the rest only occupy a miniscule position in the $5.1 trillion market. So inasmuch as the market may be deeply liquid, there isnít as wide a variety compared to the stock market.

Variety is essential to a trader when you think about it because it provides multiple investment opportunities. Consider a trading day when there is a lot of uncertainty with the value of the USD, perhaps because the Fed is about to announce a change in interest rates. A trader seeking to avoid the coming volatility would not really have many other options to trade, would they? Although some brokers offer exotic pairs, trading them is very expensive because of the additional charges in spread and swaps. Furthermore, even some of these exotic currency pairs are still indirectly affected by the US dollar. Letís say you wanted to avoid the USD and instead traded the EUR/SEK live chart. Although the USD isnít involved directly in the trade, its shift in value will affect that of the euro and most other currencies. In this way, the forex market is very limited in terms of options and this just isnít attractive to a professional trader who is trying to avoid any risks.

http://www.forex-central.net/forum/userimages/top-forex-volume.PNG


Now letís look at a stock trader who is trying to avoid risk from, say, a trade war. The trade war would affect several American and Chinese companies, but then again not across all industries, meaning that there will still be plenty of other stocks they can buy. After all, there are over 44,000 stocks around the world accessible with a simple phone call. There is still more reason why having many options is important even beyond just sheer variety Ė hedging. ETFs work so well because they include several stocks and not just a single one, recognizing that stock markets in general will go up over time.

Investment companies like Goldman Sachs have been known to report extended periods of profit making because they usually hedge against any risk in the long term. As an illustration, a professional trader would choose several companies to include in their portfolio, picking them out from different industries. For example, a pharmaceutical company, mining company, manufacturing company, media company and even throw in a sin stock for fun. It would take an extraordinary event to make all these industries to decrease in value at once. Even during the 2008 economic crisis, sin stocks did not fail because gambling and other vices were on the rise. As a result, the variety provided by the stock market could ensure that a trader is immune to massive losses regardless of the market conditions.

Thus, professional traders prefer stocks, which are many in number as they can choose freely where to allocate their resources and hedge against any risk. In the forex market, a lack of variety places a trader at the mercy of a single currency, which is very risky as we have already seen.

Forex markets tend to be more risky

Every time you trade in the forex market, you are basically placing your trust in your broker, hoping that they will keep their promises. When you think about it, this is really all we ever go by, since there isnít any actual contract signed or some other physical document. This isnít an inherently negative thing because a lot of businesses are conducted this way, but once again professional traders would rather avoid any risks. We know of tens of fraud cases that have happened in the forex market where investors lost thousands of dollars and the perpetrators made away with several million. Now imagine a professional trader handling billions, would they just hand it all over without some assurance? Of course not. This is why they prefer to trade the stock market where assets bought are Ďrealí.

The main reason fraud is common in the Forex market is because there are no centralized exchanges. When you place a trade from your Forex trading platforms, the order is transferred by the broker to a liquidity provider who subsequently transfers it to the interbank market. The interbank market is not centralized, that is to say there isnít a single location where the trades are processed. In essence, the forex market is like the internet, where information (trades) is shared directly between two opposite parties. Unlike this structure, the stock market is more centralized. Although there are various exchanges, all stocks must be bought through an exchange. When the regulators have a central point to look at, they can more effectively ensure that fraud does not occur.

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Forex regulators have a much more difficult time overseeing the forex markets because the trades are done directly between parties. This is why these regulators have been pushing for some kind of centralisation for the forex arenas, but itís proving to be too difficult. One of the regulators thatís probably the most overwhelmed is the CySEC, who have over 200 brokers under their jurisdiction. This probably translates to millions of traders signed up with these brokers, not to forget all the brokers who operate without a license.

The sheer numbers of the brokers from all over the world make it nearly impossible to track down scammers, and most of the Forex scams that happen probably go unreported for this reason. We have even seen some major investors take advantage of the decentralized nature of the Forex market. Such was the case when several investment banks like Citigroup, JPMorgan Chase, HSBC, Goldman Sachs, etc. were discovered to be manipulating prices in the Forex market during the 5:00 pm fix.

Fraud in the stock market still goes on, make no mistake about it, but it isnít as rampant as in the forex market. Because all stocks are bought through an exchange, financial regulators can easily monitor the goings-on at an exchange and prevent any fraud. Furthermore, there is usually a contract printed whenever a stock is bought, meaning that the holder has actual proof that they own the stock, after which they can do with it as they please. This ability to actually own stock gives professional traders the confidence to trade billions worth of stocks comfortably knowing that they actually own the asset.

Stock markets fits into a professionalís schedule and style

The forex market runs virtually 24 hours continuously for 5 days a week. While that may be attractive to an individual trader like you and me, itís not so much to a professional trader. For us, this 24-hour nature gives us the freedom to plan for the day and decide when we prefer to trade. It even makes it possible for someone to become a part-time trader because they can set their own time to trade.

A professional exchanger would not appreciate this as much as you do because there are just too many unknowns. Because a professional exchanger is usually hired, they have a particular time at which they go to work and then go back home. Imagine such an exchanger going to work in the morning to find that some major occurrence happened in Japan or China that has already shaken up the Forex arenas. That would be a recipe for disaster because for the entire exchanging day the exchanger would be trying to catch up to the arenas. Playing catch-up can never lead to profits as we all know because one needs to have a clear exchanging plan. Thus professional exchangers prefer the stock arena because they can prepare for the exchanging day before the arenas open.

We previously mentioned how someone picks stocks to invest in from the thousands available. The process of analysing a companyís stockís intrinsic value is a form of fundamental analysis because it takes into account those factors that actually affect the stock price. If a company is making a lot of money, itís stock will be in high demand and the value will go up. Itís that simple, even considering the other data about a companyís health. This kind of fundamental analysis is irrefutable because it involves working with concrete figures that will always lead to the same conclusions by all stock exchangers. This is why the charts of stock prices donít have extreme volatility because there is no contention in the calculations.

The same cannot be said for the Forex arena because fundamental analysis can only go so far. For one, the main source of fundamental analysis information is the economic calendar, when central banks and other financial institutions make major announcements. Their announcements only give us a general direction where we can expect the arenas to go, but it isnít as definitive as information provided by companies. For example, the Fed chair can raise interest rates, but at the same time making dovish comments, creating mixed reactions in the forex arena. On the other hand, a companyís financial statements are always very clear about the companyís health, and there are no grey areas left to interpretation.

That being said, technical analysis does come in handy when exchanging stocks. When we look at the origin of some of the most common technical indicators we use today, they were initially meant for the stock arena before being adopted in the forex arena. The only difference is that forex exchangers have to rely more on technical analysis than fundamental analysis, but it is not very precise. For this reason, professional exchangers stick to stock exchanging where they can be sure of what they are doing and not take any chances.

What about the individual trader?

Knowing why professional exchangers keep away from exchanging forex arenas, the question now becomes whether individual exchangers should do the same. The answer is no. We donít share the same motivations or apprehension that the professional exchangers do. Moreover, there are some very obvious benefits to exchanging Forex arena for an individual exchanger. Perhaps the most important is leverage, which has allowed traders to make big profits with a relatively small investment. That you can trade the forex 24 hours a day 5 days a week is an added bonus.

But the caution professionals take should also be heeded by the individual exchanger. Most importantly is to find a trustworthy broker who will not abscond with your money or give you bad exchanging conditions. You should also be more cautious in the trades you pick by being very studious in your technical and fundamental analysis. Finally, donít get greedy. They say the journey of a mile started with one step, so donít expect to turn $2,000 to $1 million within a month, but rather keep building upon it.


"Anything worth having is worth going for - all the way." - J.R. Ewing

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