Picking a Market

One of the very first questions that I faced when I embarked on the trading bandwagon was “what will I trade?”.  There are plenty of instruments one can trade on the open market, from equities and options to currencies, futures, and commodities, just to name a few.  The good news if that there is quite a bit of overlap between these instruments at least in terms of the techniques and tools that you use to trade them.  The fundamentals however tend to be different as well as the brokers and services with which you will deal.  On my journey so far I have considered two markets: Equities and Forex.  The table below provides a high level comparison between these two markets.

	Equities	Forex
Leverage	4:1	100:1
Recommended Account Size	> $25,000 (PDT)	Mini: >= $10,000
		Standard: >= $100,000
# Instruments	Thousands	7 major current pairs
Market Hours	9:30am – 4:00pm	24 hours (Tokyo, London, NYC, Sydney)
Platform/Exchange Fees	> $100/month	Free
Commissions/Pip Spread	$14/round-trip trade	$10-$40 (1 to 4 pip spread on $100K trade)

 

Leverage is very significant in the Forex market, usually 100:1 sometimes even 200:1 or 400:1, compared to 4:1 in equities.  Forex requires such high leverage because the gains that you typically make on a currency pair are in the order of 10,000th of a dollar (fourth decimal).  Therefore you need to trade in lots of $10K (mini lot) or usually $100K (standard lot) for your profits to amount to something significant.  High leverage is the way to do that.  Yet leverage is a double edge sword, while it significantly increases your buying power, it can also result in dramatic losses.  So I wouldn’t necessarily see leverage as a valid argument in favor of Forex over equities.  High leverage in Forex is a necessity.

I also provided the minimum recommended account sizes for both equities and Forex.  In equities you have to deal with ‘pattern day trading’ rules (PDT).  The SEC defines a pattern day trader as a trader who executes 4 or more trades per week.  Such traders are required to maintain an equity balance of at least $25,000 in a margin account.  PDT doesn’t apply to Forex so in Forex it’s possible to open a trading account with sometimes as little as $250.  But that doesn’t mean that you should open an account at that level.  Ideally a mini account should be open with at least $10K and a standard account with at least $100K.  If you do not have the required $10K for the mini account, it is recommended to stick with a demo account (i.e. paper trading).

Forex just has a handful of instruments compared to equities.  While the equity exchanges such as NASDAQ and NYSE offer thousands of tradeable stocks (even though only a small percentage of this number is really worth trading), 90% of the Forex action occurs on the following major currency pairs:

• USD/JPY
• EUR/USD
• GBP/USD
• USD/CHF
• USD/CAD
• NZD/USD
• AUD/USD

Market hours are in my view of the strongest arguments in favor of trading the Forex.  Indeed if you are like me and you have a full-time job, being able to trade or at least practice on the Forex after business hours is a must.  If you consider the market hours of Tokyo, Londer, NYC, and Sydney, you pretty much have an opportunity to trade 24 hours a day.  Compare this to the fact that you can only day-trade equities between 9:30 and 4:00 and you see the advantage (unless your boss doesn’t mind if you day-trade on company time).

I have found that Forex brokers usually offer better trading platforms than their equity counterparts and this usually for free.  In a typical equity trading scenario you would need to purchase a trading platform, which along with data feed and exchange fees could amount to anywhere between $100 and $175/month (e.g. Tradestation or eSignal).  Of course you could use the free platform that companies such as Scottrade offer but I think that you will quickly find that their functionality is very limited and the quality of their data feed is usually sub-standard.  In Forex, I have found a number of brokers who offer high quality trading platforms with a high quality Forex data feed at no cost.  Most if not all of these brokers also let you open a free demo account so that you can not only test-drive their platform and service but also practice with a fictitious account (paper trading).  Here I would like to highlight a company in particular, Oanda, who offers a very nice and unlimited demo account (most would expire about 14 or 30 days).

Forex brokers usually advertise the fact that they do not charge commissions, unlike their equity counterparts.  The statement is true BUT in Forex you deal with what is know as the ‘pip spread’ (i..e. the difference between the bid and ask price of a currency pair, expressed in pips).  Note that equities also have a spread (i.e. the difference between the bid and ask price of an equity, expressed in dollars) but the difference is that if you use a direct access broken (e.g. Tradestation or MBTrading for instance), the bid and ask prices are a directly results of the market’s supply and demand, they are not manipulated by market makers.  In Forex, I find that most brokers are market makers as well, therefore the pip spread is not only the result of market forces, but it is also compounded by additional charges coming from the brokers.  Basically you end up with a ’swollen’ pip spread that is greater than the one offered by the market.  So here it seems that we have two choices, we either go with a ‘broker’ where there will be no commissions per se but wider spreads or we go with a straight-through-processing house (STP) that will not affect the spread but that will charge a commission.  Personally I would pick the latter.  Indeed market makers not only doctor the spread but can also you ability to make trades (e.g. during high periods of volatility).  Being able to work directly through an STP provider, with no deal desk, seems to me to be the healthier approach.  This being said this service comes at a price, i.e. a commission, that ranges from $0.00002 (e.g. Tradestation) to $0.00005 (MBTrading) depending on the provider but this commission is partially (or totally) offset by tighter pip spreads.   Another advantage that I see in using a STP provider such as Tradestation for instance is that you can also develop a good level of proficiency with the platform and eventually transfer that proficiency to other instruments such as equities and options which are also supported by Tradestation.  Likewise if you have developed some custom code in EasyLanguage to support your Forex trading (e.g. new indicators or strategies), you could leverage the same code in trading equities.  This transferability is an appreciable advantage.  The same would not be true of Forex trading platforms that tend to only cater to Forex.

So in conclusion ‘picking a Market’ ends up being a personal decision.  There is no wrong choice here.  It all depends on what you like to do, on your style, and on your lifestyle.  Personally, at this stage of my life (having a full time job and all) it seems that Forex is the most practical choice and it is where I will start.  I will keep using this blog as a way to share my experiences learning about the Forex, paper trading, and eventually live trading.  I welcome any feedback that you may have.