The post Forex vs. Options by Chris Davis appeared first on Benzinga. Visit Benzinga to get more great content like this.
There are fundamental differences between the forex vs. options markets. Understanding the differences and choosing forex vs. options can be complicated, and everyone has their own way of investing. So, you should review both perspectives before deciding how to proceed.
Start with our guide to understand your choices and move forward with the best investment strategy.
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What is Forex Trading?
Forex is an abbreviation for foreign exchange, which refers to the buying and selling of currencies from around the world. In simpler terms, it’s like changing dollars to euros or yen to pounds. But why would someone want to do that? Well, there are several reasons why people trade in the forex market.
One of the main reasons is for international businesses that need to exchange currencies to pay for goods or services in different countries. But forex trading has also become a popular form of investment for individual traders. The aim is to buy a currency when its value is low and then sell it when its value goes up, making a profit in the process. However, forex trading is highly speculative and requires a lot of knowledge, skill and experience. This is due to the constantly changing exchange rates and the various factors that can affect currency values such as economic and political conditions.
To participate in foreign exchange trading, forex traders need to use a forex broker and a platform to execute their trades and follow market movements. It’s important to note that forex trading carries a high level of risk and traders should only invest what they can afford to lose. But with the right strategy and discipline, forex trading can potentially provide a lucrative source of income.
Pros and Cons of Forex Trading
Here are a few additional points you should consider before diving into currency trading with forex.
Pros
- Less susceptible to volatility shocks
- Highest liquidity of any financial market
- Investors protected against fraud and theft of funds through KYC standards
- Default risk limiters
- No middleman fees
Cons
- Less volatility means less short-term growth potential
- Susceptible to unexpected political events
- Gains are easily tracked and taxed
- Temptation of extremely high leverage
What is Options Trading?
Options trading involves buying and selling contracts that give the holder the right (but not the obligation) to buy or sell an underlying asset at a predetermined price within a certain timeframe. Call options and put options are the most popular types of options traded.
Options trading can be a complex and sometimes risky endeavor, but it can also be a powerful tool for investors looking to hedge their positions or speculate on the direction of the market. Unlike traditional stock trading, which involves buying and selling shares of a company’s stock, options trading allows you to potentially profit from fluctuations in the price of an asset without actually owning it outright.
Options trading can be a bit intimidating at first, especially if you’re new to investing. There are many different strategies and concepts to understand, and it’s important to do your research and make sure you understand the risks involved before getting started. However, with the right education and a solid trading plan, options trading can be a valuable tool for investors of all experience levels.
Pros and Cons of Options Trading
There are some other advantages and disadvantages to options trading based on the differences between the asset types.
Pros
- Automatic leverage
- Can create non-directional and hedging strategies
- Potentially higher ROI than trading underlying assets directly
- Less capital is required to control more assets
Cons
- Not all losses are tax-deductible
- Relatively low liquidity
- Higher barriers to entry
- Fixed fees for trading
Similarities Between Options Trading and Forex Trading
Before considering forex vs. options, it’s important to note how they are similar. The basic rules of trading — supply and demand and news absorption — apply to both markets. Understanding these rules and how they apply to all markets is essential to investment success.
To keep things simple here, we will assume that we are comparing the options markets within major trading indices (the S&P 500, the Dow Jones Industrial Average or NASDAQ) to forex trading.
Leverage
If you have a leveraged account, you can own more assets in that account than your money would normally buy. Brokers give leverage just like banks give loans. With the proper setup, you can purchase forex currency pairs or options contracts on margin, meaning that you are using leverage.
Forex brokers offer more leverage on trades. Depending on the broker you choose, you may be able to open an order at 1,000 times your own capital, for example, trading $1,000 worth of currency for every $1 you hold in your forex account.
No reputable options broker will ever have leverage this high but you must consider that options itself is leverage. Every options contract that you purchase, whether call or put option, represents 100 shares of the underlying stock.
Accessibility
Modern brokerages make it incredibly easy to trade the exact financial instrument you want. (We have a list of brokerages that you can use to trade forex and options, and you can read this FOREX.com Review for a good introduction to the most well-known forex broker in the world.) This is in stark contrast to previous generations of investors who were often limited in their choice of instruments.
You may run across opinions that advise you against forex or options because of the difficulty in accessing one instrument over the other. Check the timing and the veracity of the sources — you may be dealing with out-of-date information that bleeds over into dated investment advice.
Regulation
Both forex and options trading invoke regulations to limit the potential risk investors take on. These regulations may come from different places but they all serve the purpose of protecting traders from taking unmanageable risk.
If you plan on trading forex, you should get used to putting a stop-loss in with your buy orders. Many brokers will not allow you to execute an order without a stop loss.
By law, trading options on a U.S.-based brokerage requires that you self-assert your level of trading expertise and net worth, among other financial information. Depending on the answers you give, that brokerage will assign you an options level.
Brokerages may not check this information, but it doesn’t help you to lie. Higher options levels expose you to more trading tools but also bigger risks that you may not be prepared to take on.
Differences Between Options Trading and Forex Trading
As you might assume, there are also some major differences between options and forex. Below are three of the most important to help you determine which investment tool is right for you.
Asset Type
Forex market investors trade currency pairs, which are assets that you own directly. This is known as spot trading.
When you trade options, you are trading a contract on an asset. Options are known as asset derivatives. As such, you can actually trade options on forex currency pairs.
Options have characteristics that assets do not have and may be used in sophisticated trades that play the buy and sell side at once. Options can also lose money more quickly than assets.
24-Hour Trading
The options market is open only during the normal market hours of Monday to Friday from 9:30 a.m. to 4 p.m. EST. The forex market is open 24 hours per day even for forex beginners. During dead hours, the prices of options “freeze” even though news may be coming in that changes the market.
At the start of the new trading day, investors may experience a sudden jump in price (up or down) as the market responds to the new information. This phenomenon can cause options to completely jump over automated stops (orders you pre-fill based on certain conditions and entrust an algorithm to execute). Before committing to an options trade, you must be sure that you are prepared for these possible jumps at the start of trading.
Forex markets can experience jumps over the weekend, as the majority of forex brokers are closed on Saturday and Sunday. News will continue to flow and may cause price gaps on the following Monday. The 24-hour trading schedule of forex usually keeps huge price gaps from occurring on weekdays, although it can occur.
Volatility/Liquidity
The forex market is the most liquid market in the world. Liquidity means that trading is easy. Forex’s liquidity attracts mainstream investors who are looking for efficient, stable markets. It also makes forex the biggest market in the world.
The contrast with the options market is stark. Depending on the options you choose, you could be trading against only a few people across the entire world. Liquidity in this case is objectively lower and price becomes more volatile.
Best Brokers for Forex Trading
You must do business with reputable forex platforms to take full advantage of the market’s strengths. Consider the following list:
Commissions
Spreads start as low as $1 But vary based on trading volumeAccount Min
$2501 Minute Review
FOREX.com is a one-stop shop for forex traders. With a massive range of tradable currencies, low account minimums and an impressive trading platform, FOREX.com is an excellent choice for brokers searching for a home base for their currency trading. New traders and seasoned veterans alike will love FOREX.com’s extensive education and research center that provides free, informative forex trading courses at multiple skill levels. While FOREX.com is impressive, remember that it isn’t a standard broker.
Best For
- MetaTrader 4 users
- Beginner forex traders
- Active forex traders
Pros
- Impressive, easy-to-navigate platform
- Wide range of education and research tools
- Access to over 80 currencies to buy and sell
- Leverage available up to 50:1
Cons
- Cannot buy and sell other securities (like stocks and bonds)
Commissions
$10 value per pipAccount Min
$01 Minute Review
IG is a comprehensive forex broker that offers full access to the currency market and support for over 80 currency pairs. The broker only offers forex trading to its U.S.-based customers, the brokerage does it spectacularly well. Novice traders will love IG’s intuitive mobile and desktop platforms, while advanced traders will revel in the platform’s selection of indicators and charting tools. Though IG could work on its customer service and fees, the broker is an asset to new forex traders and those who prefer a more streamlined interface.
Best For
- New forex traders who are still learning the ropes
- Traders who prefer a simple, clean interface
- Forex traders who trade primarily on a tablet
Pros
- Easy-to-navigate platform is easy for beginners to master
- Mobile and tablet platforms offer full functionality of the desktop version
- Margin rates are easy to understand and affordable
- Access to over 80 currency pairs
Cons
- U.S. traders can currently only trade forex
- Customer service options are lacking
- No 2-factor authentication on mobile
Commissions
0.09% spread costAccount Min
$501 Minute Review
Though Australian and British traders might know eToro for its easy stock and mobile trading, the broker is now expanding into the United States with cryptocurrency trading. U.S. traders can begin buying and selling both major cryptocurrencies (like Bitcoin and Ethereum) as well as smaller names (like Tron Coin and Stellar Lumens).
eToro offers traders the opportunity to invest their assets into premade portfolios or cryptocurrencies, similar to services offered by robo-advisors through traditional brokers. Though eToro isn’t a one-stop-shop for everything an investor needs, its easy-to-use platform and low spreads is a great way to enter the cryptocurrency market.
Best For
- International Forex/CFD Traders
- New cryptocurrency traders looking for an easy-to-use platform
- Traders who want to buy and sell cryptocurrencies on-the-go
Pros
- Simple platform that is easy to master
- CopyTrader feature that allows new traders to copy the same strategies used by professionals
- Virtual dummy account that gives you $100,000 to practice trades
Cons
- U.S. traders currently limited to cryptocurrencies
- Only 15 major coins available to trade
Best Brokers for Options Trading
If you’re trading options seriously, your options broker will definitely influence your chances of success in the market. You may want to test the following brokers to see which best fits you:
Commissions
$0Account Min
$01 Minute Review
Webull, founded in 2017, is a mobile app-based brokerage that features commission-free stock and exchange-traded fund (ETF) trading. It’s regulated by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA).
Webull offers active traders technical indicators, economic calendars, ratings from research agencies, margin trading and short-selling. Webull’s trading platform is designed for intermediate and experienced traders, although beginning traders can also benefit.
Webull is widely considered one of the best Robinhood alternatives.
Best For
- Active traders
- Intermediate traders
- Advanced traders
Pros
- No account maintenance fees or software platform fees
- No charges to open and maintain an account
- Intuitive trading platform with technical and fundamental analysis tools
Cons
- Does not support trading in mutual funds, bonds or OTC stocks
Commissions
$0 $6.95 for OTC StocksAccount Min
$01 Minute Review
This publicly listed discount broker, which is in existence for over four decades, is service-intensive, offering intuitive and powerful investment tools. Especially, with equity investing, a flat fee is charged, with the firm claiming that it charges no trade minimum, no data fees, and no platform fees. Though it is pricier than many other discount brokers, what tilts the scales in its favor is its well-rounded service offerings and the quality and value it offers its clients.
Best For
- Novice investors
- Retirement savers
- Day traders
Pros
- World-class trading platforms
- Detailed research reports and Education Center
- Assets ranging from stocks and ETFs to derivatives like futures and options
Cons
- Thinkorswim can be overwhelming to inexperienced traders
- Derivatives trading more costly than some competitors
- Expensive margin rates
Commissions
$0 flat rate, includes closing costsAccount Min
$01 Minute Review
Tastytrade is a sophisticated options and futures broker aimed toward experienced traders. The platform was designed by the founders of thinkorswim with functionality and precision for complicated options trades and strategies. Tastytrade offers stocks and ETFs to trade too, but the main focus is options.
Options on tastytrade are only charged a 1-way, $1 commission — far cheaper than almost all competitors. Commissions on futures and micro futures are also affordable, and there’s no minimum required to open a cash account. It’s $2,000 if you want to use margin.
Best For
- Options traders
- Futures traders
- Advanced traders
Pros
- Powerful platform inspired by thinkorswim
- Multiple order types and strategies
- Cheap options commissions
Cons
- Advanced platform could intimidate new traders
- No demo or paper trading
Currency or Derivatives?
Forex currency pairs and derivative options are two different asset classes, which naturally produce different strategies for success. When you are deciding the next market to take on, consider your own personality and investment goals before committing to 1 or the other.
If you have more than $30,000 and you are willing to forego some short-term growth for a smoother experience, the forex market may be your play. If you have less money, need built-in leverage and don’t mind a bit of volatility, then options could work for you.
As always, never invest money that you are not willing to lose. No matter where you stand in the battle of forex vs. options, these markets and asset types carry risk.
Frequently Asked Questions
Do I need to implement a stop-loss?
Yes. A stop-loss will automatically close out of trading if you reach a predetermined amount of losses. You can also put a stop-limit on a single currency you’re holding to tell your trader to sell if the currency ever reaches below a predetermined price. It’s important not to bid more than you can afford.
How can forex charts help me?
Forex traders rely on charts in order to make calculated guesses about how a currency value will change by observing historical fluctuation patterns. Most charts have personalized setting options so you can view a variety of technical indicators to analyze price movements.
The 3 most common forex charts are bar charts, line charts and candlestick charts. See Benzinga’s article on Best Forex Charts for more details.
What are the benefits of trading forex options?
Several of the advantages include liquidity and 24-hour trading.
Can you make more money trading stock or forex options?
Forex options give you leverage to increase returns.
The post Forex vs. Options by Chris Davis appeared first on Benzinga. Visit Benzinga to get more great content like this.
