Forex VS Indices: should you trade them the same way?

 

A huge range of markets all sit there on our trading platform waiting for us to dive in. And they all look very similar.

So we’d be forgiven for thinking they’re interchangeable.

And if I’ve got a trading system that works on EURUSD, what’s to say it won’t work just was well on USTech or the FTSE?

But there are some practical and fundamental differences when looking at Forex VS Indices, and a little understanding of this will help you find the RIGHT market for the RIGHT trading method.

First, I’ll look at 5 obvious areas of difference and similarity that should be considered when comparing any markets (whether they’re forex or indices, or anything else). But then I’d like to dig a little deeper, at a fundamental mind-shift that’s needed when you consider what’s driving these two systems.

1. Assets vs Relationships

It used to be the case that you could only benefit from the up-side of stock markets, while forex allowed more versatility. But spread-betting has allowed ordinary traders to make money whether the markets are going up or down.

Whether you’re ‘buying’ or ‘selling’ an index, its value stems from the underlying assets – what the companies that make up that index are worth.

Forex markets, in contrast, are about a relationship between two things. As the value of one thing moving against another. We always trade them in pairs, buying one currency, while selling another.

2. Looking at leverage

If you’re trading individual shares, you’ll have a significant margin requirement of 20%, but I’m looking here at trading indices, which are a more similar beast to the forex markets when it comes to leverage.

Major FX pairs have a margin requirement of 3.33%, while minor FX pairs have 5% requirement.

In comparison, for major indices, you’ll be paying 5%, and for minor indices, its 10%.

Depending on the size of the instrument you’re trading, these small percentage differences can be a big drain on your account.

3. Comparing liquidity

The FX market is HUGE. It’s the largest and most liquid market on the planet.

Liquidity is to do with the availability of buyers and sellers. If you consider a small market, with limited liquidity – like a small-cap share – it can take some time to find a buyer if you’re selling, and the price can slip in that time.

With forex, there’s pretty much always someone on the other side of the market, so you don’t have these issues.

Nothing – even huge stock market indices – can compete with Forex in terms of liquidity. However, for the purposes of ordinary spread-betters, there’s plenty of liquidity in major indices for our needs.

4. What moves these markets

If you’re trading an individual stock, you’re only interested in that company and their industry sector. If you’re trading an index, then you’ve got to expand that frame of reference to many more industries – and an entire country. But if you’re looking at forex, then the fundamentals are even broader – taking in market forces across the planet!

But that’s not exactly true … the reality is that major indices are filled with international companies, which are driven by the global economy as a whole.

5. Trading times

Stock markets have opening and closing times. In between these times, some brokers offer trading prices, but these are based on futures markets, and can be a bit ‘iffy’.

However, Forex markets are open 24/7. Different currencies have different busy periods, but they are all accessible around the clock.

What’s really going on in these markets and driving them forward

There’s a really fundamental difference between stock markets and forex, which affects long-term traders in particular, but is often overlooked.

As anyone who’s ever bought anything will know … stuff just keeps getting more and more expensive. Stock markets will have bull runs and bear runs … but their value tends to keep climbing over the long term.

Here’s a chart showing the FTSE since 1984 …

In which time, its value has grown around seven fold.

Now let’s look at the chart for GBPUSD over a similar period (this actually goes back to 1977) …

There’s a clear difference in what’s driving these two markets.

The stock market is being driven upwards. The forex market keeps being drawn back to an ‘average’ price.

This magnetic pull is called ‘mean reversion’ – it’s when prices are naturally drawn to a stable middle-ground. We see it at work in shorter timeframes for all markets (including indices), but with forex, it’s always at work.

I’m not suggesting there that we should only trade mean-reversion strategies on FX markets, and only trend-following strategies on indices … Forex pairs can spend plenty of time in a trend, just as indices can be range-bound.

But it’s all about remembering the bigger picture, which is so easy to lose sight of in the heat of the trading battle.

 

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