Forex Market versus Stock Market

Forex Market versus Stock Market
Since most of you are familiar with the stock market, this is a good
place to start. The stock market has been the traditional investment
of choice for most retirement accounts. The accessibility of the stock
market and the fact that the United States has the best stock market
in the world make it a logical place for serious investors. Along
with outstanding benefits, the stock market also has a few inherent
gaps that the Forex market can fill. Some of these gaps are particularly
relevant to the active investor who trades frequently. Others
are important to every stock market investor.
Gap 1: Commissions Each time you trade one of your stocks
(or mutual funds), either by entering or exiting a position, you incur
a commission charge. In most cases, the charge is much greater if
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you actually need to speak with a broker to execute your trade.
Imagine that you own several shares of Google’s (GOOG) stock, and
you are concerned with the effects an upcoming earnings announcement
might have on the value of your stock. You decide to call your
broker to make a trade and ask for some advice. It’s going to cost you.
We took an informal poll of the largest online stockbrokers
and found an average charge of $50 per trade in this situation. Those
kinds of fees can add up. Plus, that fee was only for the sell order.
Had you wanted to purchase the stock, you would have had to pay
twice that amount, or $100. Now imagine how much it would cost
if you wanted your broker to help you execute several orders on
multiple stocks. You get the idea.
By contrast, almost every dealer in the retail Forex market offers
commission-free service. Plus, you can talk to most Forex dealers in
person as many times as you need to for free. Most Forex commodity
trading advisors also operate on a commission-free basis. You should
certainly do your homework to make sure that you are dealing
with a dealer who is giving you the best treatment, but most offer
comparable arrangements.
Gap 2: Market Hours The U.S. stock markets are open from
9:30 a.m. to 4 p.m. Eastern time Monday through Friday. This is
right in the middle of business hours. Because most retail stock
market investors are at work during these hours, many cannot enter
stock trades during the day when the stock market is open. Instead,
they have to “roll the dice” by placing orders when the stock market
is closed and hope they will get into or out of their trades at a
favorable price when the market opens the next day. If the stock
opens at around the same price it closed at the previous day, you
get a good price on your trade. If the stock opens at a much higher
price than it closed at the previous day, you can get a very unfavorable
price.
The Forex market is open 24 hours per day, from Sunday afternoon
through the following Friday evening. Because the market is
almost always open, you can enter your trades whenever you have
time. And your orders will be filled within fractions of a second
thanks to the multitrillion dollar volume the Forex market enjoys—
even in the middle of the night. The exceptionally high volume
that occurs on the Forex market also helps fill the next gap in the
stock market.
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Gap 3: Liquidity Liquidity can be an issue when you are trading
smaller stocks. Liquidity refers to your ability to sell, or liquidate, an
investment you may be holding. If you can sell it quickly, the investment
is a liquid investment. If you can’t sell it quickly, the investment
is an illiquid investment. Imagine that you own a small-cap or microcap
stock, and you need to exit your position quickly. Chances are
you will receive a much lower price for your stock than you were
anticipating. This is especially the case if the stock is experiencing
bad news.
Mutual funds, as we mentioned earlier, are not liquid during
market hours because you can buy or sell them only once the market
has closed. Some mutual funds even have restrictions on when you
are eligible to sell them without incurring penalties. The lack of liquidity
found in mutual fund investing can keep you out of trades
that are making money or keep you in trades that are losing money.
The Forex market has more liquidity (buyers and sellers) than
any other financial market. This means that if you want to get into a
trade, there will always be somebody there to sell it to you. And when
you want to get out of a trade, there will always be somebody there
to buy it from you. And you can do all this at a reasonable price.
Gap 4: Taxes Taxes are one of the biggest concerns any stock
investor must address. Making profits every month in your investing
is wonderful. But if you do not have your investments sheltered in
an IRA or other protected account, you will be charged a short-term
capital gains tax on all your profitable trades that lasted less than
one year. In some cases, this can mean a tax hit of more than 30 percent.
Most of you probably have the majority of your investments
in tax-sheltered accounts. However, even tax-sheltered accounts
have a gap. The drawback to these accounts, of course, is that you
don’t really have access to that money—without penalties—until
you are 591⁄2 years old. That’s right. If you take your money out of
a tax-sheltered account before you are 591⁄2, you will have to pay an
additional penalty—which currently stands at 10 percent. That can
make a huge difference in your account balance.
By contrast, short-term Forex profits are taxed at a much lower
rate. Each time you make a gain in the Forex market, as we outlined
previously, 60 percent of your profits automatically qualify as longterm
capital gains, while only 40 percent of your profits are considered
short-term gains. And for those of you who are wondering,
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you can invest in the Forex market through a retirement account,
like an IRA, as well. So, you can enjoy the best of both worlds.
Gap 5: Bear (Downtrending) Markets Bearish stock market
conditions are usually something that stock and mutual fund
investors patiently endure. Some more advanced, and usually more
wealthy, stock investors, however, are able to try to take advantage
of bearish market conditions by shorting stocks. Shorting a stock
means that you: first, borrow a stock from your broker; second, sell
that stock on the open market at whatever the going rate is; third,
wait and hope the stock drops in value; fourth, buy the stock back
(hopefully at a lower price); and fifth, return the stock plus interest
to your broker. If the stock declines in value while you are shorting
it, you make money. If the stock increases in value while you are
shorting it, you lose money. Shorting a stock is risky and expensive.
Plus, not everyone qualifies to short stock. You have to have enough
experience and enough money before your broker will even allow
you to try to short stocks. Additionally, when you do short a stock you
have borrowed from your broker, your broker charges you interest.
Perhaps the biggest drawback of shorting stocks is the “uptick”
rule. If you see and want to take advantage of a stock that is dropping,
you can’t just jump in and immediately start shorting the stock.
You have to wait until the stock creates an uptick. An uptick occurs
when the stock trades at a price higher than it was previously. So if
a stock drops from $50 to $49 to $48 to $47, it has not experienced
an uptick, and you cannot short it. If, however, the stock rises back
up to $48 after it has dropped to $47, it has experienced an uptick,
and you can now short it. As you can imagine, most stocks that are
falling tend to fall rapidly, and it is very difficult to find upticks.
This can keep you out of a lot of trades even though you know the
stock is going down.
Taking advantage of a downtrend in the Forex market is much
easier than shorting a stock if you want to take advantage of a bearish
market. It is as simple as this. If you think something in the Forex
market is going up, you click on the “buy” button. If you think something
in the Forex market is going down, you click on the “sell” button.
How easy is that? You don’t have to qualify for any additional
trading permission. You don’t have to ask your broker if you can
borrow anything. And, most importantly, you don’t have to wait
for any nebulous upticks. If you see something headed down to
the floor, you can jump in and take advantage of it any time you
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please. Imagine being able to take advantage of both uptrends and
downtrends with just the click of a button.
Gap 6: Analysis Overload The stock market offers an incredible
selection of investments. There are literally tens of thousands of
stocks and mutual funds to choose from. How in the world are you
supposed to make an informed decision about which ones are the
best to buy and which ones are the best to sell? Even your broker isn’t
able to stay on top of every stock and every mutual fund. To combat
this problem, most of us have diversified our stock and mutual fund
portfolios to cover a broad range in the market. This works pretty
well because it lets you take advantage of movements in various
segments of the market. It does, however, make it difficult to keep
track of and load up on the stocks and mutual funds that are going to
do well and dump the stocks and mutual funds that are not going to
do as well.
The Forex market is much simpler to monitor. You really need to
keep track of only eight different currencies. That’s right: eight. Even
if you don’t have a lot of free time, you can keep track of something
for which you need only two hands to count. (We talk more about the
eight currencies you’ll need to keep an eye on later in the book.)
Forex Gap To ensure we are giving you a balanced view, and to
emphasize that we are not issuing any type of Chicken-Little warning
to pull out of the stock market, we want to highlight a gap in the
Forex market that the stock market fills.
The overall Forex market is a trend-neutral market. This
means that it moves up and down. But once you net out the ups
and the downs, it is basically a flat market. The stock market, on the
other hand is a predominantly uptrending market. This means that
although the stock market fluctuates up and down, it has moved up
over the long haul, as you can see in Figure 1.2. When a market is
predominantly uptrending, it is generally easier to invest in for the
long term without having to do a lot of thinking. You can just put
your money in and trust that the market will go up.
However, this steady uptrend can also be counterproductive
because it lulls investors into a false sense of security. If you believe
the stock market is always going up, you probably are not going to
pay as much attention to the market as you should. You don’t have
to look back any farther than the dot-com crash that started in 2000 to
see this illustrated. Although the market has bounced back a bit since
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F I G U R E 1.2
Stock market trends: S&P 500 from 1959 through
2005, quarterly intervals
Source: Prophet.net
F I G U R E 1.3
S&P five-year chart, monthly intervals
Source: Prophet.net
its low in 2002, it has still not recovered all its losses. (See Figure 1.3.)
We are confident that the market will recover all its losses in the long
term, but you could have saved yourself a lot of heartache if you
had known about the Forex solution.
Keep investing in the stock market. Apply all the sensible rules
and practices you have been taught. Then go one step further and
really put the odds in your favor by minding the gaps with the Forex
market.