Many people in the current age have started to wake up to the importance of financial literacy. With financial knowledge and training, people will have better insight and training about their investment plans.
When it comes to investing, there are several markets and avenues open for new traders that can overwhelm investors who are just getting started. This article is going to draw a comparative analysis of two major investment markets, Forex, and Cryptocurrencies, to help the reader get hold of the basics and understand the ideal option for their investment careers.
What is Forex Trading?
Every country has a different legal tender or registered money that the citizens can use as an exchange of value. For example, people in the USA use dollars, while the citizens of China use Yen for making their everyday transactions.
However, in international markets, the legal tender of one country can be exchanged for the legal tender of another. For instance, when a person travels from China to the USA, they have to exchange their Yens for USD.
Forex trading is the process of buying and selling different types of currencies to earn profits. Forex traders take advantage of the difference in value in different currencies and hold on to legal tender from several countries. As time passes, the value of one legal tender can rise or fall based on several economic factors, such as demand or supply, etc.
Forex traders keep an eye on these changes and make their move when they can sell a reserved legal tender for a higher price.
Origin of Forex Trading
Forex Trading can seem like a fairly recent phenomenon since the democratic political system prevailed as recently as the 20th Century. However, the earliest record of Forex trading can be traced back as far back as 1000 years.
Usually, Forex Trading is attributed to Monte Dei Paschi, the first bank or oldest banking enterprise in the world founded in Italy, and it was created for trading currencies.
The first dedicated Forex trading market was created in Amsterdam, the Netherlands, around 500 years ago. Currency exchange taking place in Amsterdam assisted in preserving the inherent value of the local legal tender. Therefore, from there, the Forex trading practice was spread and adopted all around the world.
Advantages of Forex Trading
Capital Efficiency is the measure of the skills of a broker or a trading company to manage and expand their investment capital reserves. For different types of investing, options traders borrow funds from angel investors or other resources, which is referred to as Leverage trading. Leverage effectively increases capital efficiency for investors.
However, forex traders can start their positions with a minimal amount of lot size depending on personal financial capacity:
- Micro Lot: 1000 units of legal tender.
- Mini Lot: 10,000 units of legal tender.
- Standard Lot: 100,000 units of legal tender.
At the same time, forex traders do not have to take the risk of leverage trading when they are only starting and gaining experience. Therefore, they can manage their risks and avoid massive loss windows in case of unexpected market changes.
At the same time, in most cases, legal tenders are backing up an entire nation; therefore, they cannot experience sudden price degradation like stocks or cryptocurrencies in most cases.
Forex Trading is decentralized in the sense that it is not a physical entity. Traders can purchase or sell different currencies at any time and from any place. At the same time, Forex trading keeps happening 24/7.
While working with currencies of different countries, the traders can also manage security trading and gain insights into the economic and commercial landscape of different regions that can help them gain more experience in the market dynamics.
Forex Trading is very cost-effective in the sense that it does not require any lengthy commissions for the brokers, and the traders can perform individually as well. The cost per transaction is low, and most brokers charge based on PiP or Points in Percentage.
Sometimes, forex brokers offer small spreads, and it can also eliminate the trading commission. At the same time, the traders do not have to account for using platforms such as exchange markets, custodial services, withdrawals, and other trading services that are customary for other investing options.
Furthermore, traders usually do not have to worry about a lack of liquidity in forex. Additionally, Forex trading can also serve as hedging against inflation.
Stock markets usually open for a determined amount of time. However, forex trading can remain operational 24/7 and around the clock. When the stock market of one country closes, the stock market of another nation can start its business hours. The business hours for the stock exchange are divided as follows:
- Sydney Session or Pacific Session
- Tokyo Session or Asian Session
- London Session or European Session
- New York Session or North American Session
Forex trading is great for students and investors who have only started to dabble their feet in financial markets. On account of limited risks, high liquidity, and other trading liberties, Forex traders can implement and experiment with various types of investing strategies to gain experience and find out what works best for them.
Even the most experienced investors are not hesitant to implement a wide variety of different trading styles and methods with Forex trading, such as:
- Position Trading: Holding a trading position for long durations to realize maximum profits.
- Day Trading: Buying and selling trading assets within 24 hours to generate capital gains.
- Scalping: Short-term selling and purchase of investment products and making profits with small marginal changes, and sticking to strict trading strategies.
- Swing Trading: Using technical analysis to capture short-to-medium gains in investment assets for a trading duration ranging from a few days to some weeks.
Forex trading grants the freedom of investors to pick a currency pair independently and presents countless options. There is no intervention or restrictions from the government regulators. However, at the same time, Forex traders also have sufficient and suitable regulatory clarity from regulatory agencies such as:
- Securities and Exchange Board of India/ SEBI
- Australian Securities and Investment Commission/ ASIC
- Financial Conduct Authority/FCA
- Commodities and Futures Trading Commission/CFTC
Limitations of Forex Trading
Lack of Transparency
Since the Forex Trading market is intrinsically decentralized, it results in a lack of transparency for the investors. Here are some ways that forex investors can experience a lack of transparency:
Counter Party Risk
Counterparty risk refers to the phenomenon that the other party involved in a financial contract is unable to honor their part of the bargain. There are rules and regulations in place to prevent losses for Forex traders.
However, forex trading is an international market, and it is near impossible to precisely gauge all the changes that are happening in the markets around the globe. At the same time, investors are not bound by any formal contracts.
Forex markets remain operations around the clock and 365 days a. Therefore, investors are unable to keep an eye on every singular change in the market at all times. Consequently, they have to depend on algorithms and news from the media. Therefore, there is a possibility of error in the trading decision or strategy.
Furthermore, investors can also feel pressure and burnout from the forex market because it is open and changing at all times.
Forex trading can seem a very easy and lenient way of making money for many investors, and they can end up starting with a massive leverage position. However, the investors may end up underestimating the market dynamics and become susceptible to massive losses in the wake of sudden market changes if they are not prepared to deal with margin calls and maintain their leveraged positions.
Complex Technical Analysis
Technical analysis and projections for Forex trading are not as straightforward as stocks or cryptocurrencies. The forex market is affected by several volatile factors, such as political changes, economic drivers, local business communities, GDP, natural conditions, and central bank policies, among other factors. Therefore, basic technical analysis is not sufficient to read the market conditions, and it can mislead investors who are not looking out for these variables.
The forex market is always volatile, and it can be good news for investors. However, while volatility can significantly increase their profit margin, it has the equal possibility of tumbling down with the same magnitude.
What is Crypto Trading?
Crypto trading has become a pop-culture phenomenon in the current day and age. However, it also holds some important trading benefits, such as diversification of investment. Cryptocurrencies are a digital representation of money, and they are present in encrypted and digitized forms.
Cryptocurrency trading is the method of using different trading techniques to earn money by selling, purchasing, lending, and borrowing these digital tokens. Cryptocurrencies are related to a blockchain, and they can be divided into different types, such as stablecoins, tokens, NFTs, and CBDCs, depending on their origin and functionalities.
Origin of Crypto Trading
Crypto Trading started with the birth of the Bitcoin blockchain, which issued a coin with the same name in 2009. As per the White paper about Bitcoin, the blockchain was created by Satoshi Nakamoto, and it was a fully decentralized, open-sourced, peer-to-peer, and permissioned network.
Bitcoin blockchain uses the Proof-of-Work consensus model for verification of transactions, and its total supply is capped at 21 million. After the introduction of Bitcoin, several new blockchains came into being, and some gained considerable traction, such as Ethereum, Cardano, XRP Ledger, Binance Smart Chain, and others.
Today, the cryptocurrency market is considered a $3 trillion market, and financial regulators of the world have started to introduce legislative clarity for cryptocurrency traders and trading.
Comparison Between Forex and Crypto Trading
The cryptocurrency market took 12 years to reach a $3 trillion aggregate market cap. However, it is complicated for anyone to measure the exact market capitalization for forex trading as it is a global phenomenon.
However, Economists can gauge the aggregate value of the available economies of the world to determine Forex market strength. As per a 2019 report published by the Bank of International Settlements BIS, the total value for forex trading is estimated at around $6.6 billion per day.
In comparison, the roughly estimated per-day trading volume for the cryptocurrency market is projected at $100 billion to $500 billion per day. These figures are sufficient to compare the margin of profits from both investment options.
However, investors should take into consideration that the cryptocurrency market has only been around for a decade, while Forex markets have corrected and evolved for more than a thousand years.
Participation of Investors
Before MicroStrategy became the first enterprise to add cryptocurrencies to its commercial investment portfolio, the participation in crypto was mostly retail. For a massive part of the cryptocurrency presence, the cryptocurrency investors consisted of miners, individual investors, and brokers.
However, after the commercial debut of cryptocurrencies, whale investors started to take up high stakes in the cryptocurrency markets. The enterprise adoption happened for crypto as recently as 2020.
In comparison, multinational companies and governments have been participating in forex trading for decades in the end as they have to make international cost accounts. Banks use yards as a measurement for a unit of currencies counted as one billion. Taking inspiration from banks, forex traders have been practicing currency exchange to net off bigger banks using the latest technology, such as online transfers.
Cryptocurrency trading was created for the benefit of small investors. On the other hand, forex exchange by design is for the assistance of big players such as banks and governments. While crypto moved from retail to commercial adoption, forex over time evolved to serve individual investors while remaining operational among high-net-worth users.
Legal tenders always serve as the intermediary currency for investors. For example, investors have to purchase Apple stocks using USD. Forex traders have developed a detailed understanding of swapping pairs.
The currencies with the highest value in the world are used to create a table of different sets of popular forex trading pairs. Only 7 top currencies i.e. USD, EUR, GBP, NZD, JPY, AUD, and CAD, can create 21 different forex pairs.
On the other hand, cryptocurrencies are only in their early stage of development, and in most cases, users have to purchase intermediary currencies such as Tether, Bitcoin, and Ethereum to make any other trade in the crypto market.
Furthermore, every independent cryptocurrency enterprise, such as exchanges and swaps, uses their native tokens as interim currency. Furthermore, one blockchain can issue more than one cryptocurrency.
As per data from CoinMarketCap, there are around 10,000 unique cryptocurrency variants, and investors can’t find out optimum trading pairs from such as massive range.
Tax on Trading
Forex traders have the freedom to choose the best regulatory framework for their portfolio before commencing their trade. As per IRS taxation laws, the traders can take their pick between Section 1256 and Section 988.
Section 1256 treats 60% of all forex gains and losses as long-term and 40% as short-term gains or losses impervious to the trade position duration. Meanwhile, Section 988 treats all gains and losses as regular income. Forex traders can benefit from Section 1256 if they are in profit, while Section 988 is better for losses.
Meanwhile, cryptocurrency traders usually are not bound by regulatory hassle. In other instances, some governments have imposed the same laws on crypto traders as stock investors. If cryptocurrency investors keep their trading account open for 365 days or less, their revenue is taxed as per short-term investing.
On the other hand, when investors hold their cryptocurrency reserve open for 366 days or longer, they are taxed as per long-term gains or losses. Long-term taxes are always smaller than short-term losses.
Forex traders have to pick their regulatory route ahead of their trading period, while cryptocurrency investors have better control of their investment as they can opt to pick after their trading position is closed.
Typically, only 25-35% of forex investors can remain in the green after the passage of a quarter. Despite the lack of risks and controlled volatility of fiat currencies, such a massive percentage of losses occurs on account of leveraged positions. Leverage trading allows investors to take huge profits from the market.
However, it can also increase the risk of losses by many folds. The market need only move in fractions to trigger a margin call, and it can remove a major portion of profits for forex traders. The dynamics in cryptocurrency markets are also quite similar to the forex market in terms of profit percentage only difference being that cryptocurrencies garner high price volatility as well.
However, investors can manage their risks for both forex and cryptocurrencies using the latest trading algorithms, working in tandem with brokers, and using arbitrage.
Crypto and Forex are both open for trading around the clock. However, forex traders can breathe and pause trading during the weekends. There are only some Forex traders and brokers who keep trading during the weekends as well, but they charge extra commission. On the other hand, the cryptocurrency market never sleeps.
The main reason for conducting a comparative analysis of Crypto and Forex trading is not to pick out a champion. Investors can understand the various benefits of how to navigate through both options and diversify their investment portfolios effectively.
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