If you are new to trading, you may feel overwhelmed by the wide selection of instruments and investment products available: forex, stocks, ETFs, options, futures, bonds, commodities...? Which of these are the best to trade as a beginner?
This guide looks at the popular instrument types and their advantages and disadvantages as trading vehicles for a less experienced trader. We will consider how easy or hard it is to learn the technicalities (some products are more complex than others), capital requirements, profit opportunities, risk considerations, and not least, how favorable or unfavorable position a small trader has in that market relative to the big professional and institutional players.
On this page:
- Most people should trade forex or stocks
- Why not futures and options
- Should you trade forex or stocks?
- Regulation and conflict of interest
- Pattern Day Trader rule
- Short selling
- Fundamental factors
- Number of instruments
- Volatility and risk
- Trading opportunities
- Specialist first, generalist (maybe) later
Most people should trade forex or stocks
For 99% of people without prior financial markets experience (unless you have an uncle who works as trader in some other market and can teach you), it is best to focus either on forex or stocks. These are the two most popular markets for small individual traders (not only beginners), and for good reasons:
Both forex and stocks are very liquid. There is high volume of trading activity and you don't need to worry too much about execution of your trades.
There is a wide range of brokers for stocks and forex. High competition means good services, easy to use apps and tools, and low trading costs.
Both forex and stocks are fairly simple products, allowing you to learn the basic mechanics of the markets very quickly. You don't need to worry about things like expirations, settlement or assignment as you would with futures and options.
Why not futures and options
Complexity is one reason why I don't recommend futures and particularly options to beginners, despite running a consultancy and selling option trading calculators at Macroption.
In my own case, I first learned stocks, bonds and currencies (I worked in the financial industry) and only later after I gained solid understanding of these instruments I ventured into futures and options, which became my eventual favorite.
Futures and options are the so called derivatives – instruments which are derived from (based on) other instuments. These "other instruments" (known as underlying instruments or simply underlyings) are often stocks, stock indexes or currencies, so it makes sense to first learn to trade these before learning their derivatives.
Futures and options add another layer of complexity, which is unnecessary and will impede your learning progress as a beginner.
Don't be fooled by the advertising of brokers and trading websites claiming trading is easy and you can make huge instant profits with little knowledge. There is a reason Wall Street banks hire the brightest people from the best universities and still train the new employees thoroughly before allowing them to trade bigger positions. Trading is hard and requires good understanding of the instruments you trade. Markets have a way to punish ignorance.
Should you trade forex or stocks?
While either forex or stocks are suitable to beginner traders, each is a little different and each is more suitable to a different kind of beginner trader. Let's explore the main advantages and disadvantages of forex and stocks compared to one another.
Regulation and conflict of interest
Stock trading is more regulated than forex trading. You may have your own opinion whether regulation is good or bad, but truth is, it is mixed. It restricts you and protects you (from yourself and others, as in this case).
Stocks are traded on stock exchanges, while most forex trading takes place "over the counter" (OTC) – between individual institutions. With a stock trading brokerage account, you will most likely have direct access to actual stock exchange quotes and the other side of your trades will be other, unknown traders or firms.
On the contrary, with a typical forex trading account, the other side of your trades is often (not always) taken by your broker, leaving some risk of conflict of interest.
With large and reputable forex brokers, this is not a problem at all, but some smaller and less known forex firms may be outright taking advantage of their customers and the infromation assymetry arising from their relationship.
In other words, particularly with forex brokers, broker selection is essential to even having a chance for trading success.
Pattern Day Trader rule
That said, the greater regulation of stock trading places some restrictions on what you can and can't do.
For instance, if you have a small account (less than $25,000), the so called pattern day trader rule restricts the number of intraday trades (buy and sell the same stock in one day) which you can make to 3 in 5 consecutive trading days. If you make a fourth "daytrade", your broker is required by law to restrict your trading activity for as long as 90 days (or until you fund your account above $25,000).
This rule applies to all US-traded stocks (and US-traded options too). It also applies to foreign traders trading in the US markets. It does not apply to US based traders trading on foreign stock markets.
If you want to trade in both directions (long and short, speculating on a market going either up or down), it is easier to do that in forex, which generally works the same in both directions.
Short selling a stock is more complicated; if you are a beginner, I strongly suggest to focus only on long stock trades initially.
Stocks are generally a bit more complicated than forex, but not that much more.
Forex markets are driven by "macro" (country level) developments – such as politics, macroeconomic indicators and news, or actions by the Fed.
The stock market as a whole is also affected by these, but individual stocks are also subject to industry and company level issues. Therefore, stock traders have more things to watch than forex traders, especially if their trading style is based on fundamentals more than on technicals. This means more work, but it can also mean more potential trading opportunities. Which brings us to the next point...
Number of instruments
With stocks, the number of instruments you can possibly trade is much greater than with forex.
There are only 180 recognized currencies in the world today, and not all of them are available for trading (some countries restrict trading in their currency).
On the contrary, there are several thousand stocks listed in the US alone, and multiples of that in other parts of the world.
Volatility and risk
Stocks are sometimes considered riskier than forex.
A single company can go bankrupt and its stock can go to zero – this happens regularly, even in good economic times.
While countries and their currencies can also go bust at times, it is less common. The most heavily traded currencies of developed nations (like EUR, JPY, GBP, CHF or AUD) tend to be much less volatile (making smaller moves) than the most heavily traded stocks (like Apple, Facebook or Microsoft). This doesn't mean a major currency can't go wild (such as GBP in Brexit times).
Although currencies are normally less volatile than stocks, their volatility and risk can be amplified with leverage, which means your broker allows you to take on a larger position than what you could otherwise afford with your cash balance. While leverage is used in both forex and stocks, it is much more common (and the leverage factor is often much higher, such as 1:50) in forex trading.
Always remember leverage works both ways – it can increase your profits, but also your losses.
While the top stocks (like Apple or Uber) or currencies (like the euro) dominate the news at most times, often the best trading opportunities can be found in the second or third tier stocks and currencies – not the most popular ones, but the ones a bit smaller and less widely followed, though still liquid enough to allow smooth trading.
In terms of trading opportunities, which particular stocks or which currencies you trade matters more than whether you trade stocks or forex in general.
Specialist first, generalist (maybe) later
Whether you choose to start with forex, stocks, or something else, stick with it at least for a while. Allow yourself time to learn that market, perhaps make the beginner mistakes and build experience.
The worst thing a beginner can make is jump from forex to stocks to futures to options and back to forex, never really focusing long enough on one market and never learning anything in sufficient depth. That is a sure way not only to losing money, but also to an unhappy and frustrating trading experience.
Don't get this recommendation wrong. Once you become more experienced, you will start to see how the different markets influence each other (after all it is one big globally interconnected market these days) and how certain instruments are more suitable to trading a particular situation than others.
Some traders remain specialists in one instrument type their entire career, while others gradually become more generalist and trade across markets. Either approach can be successful in the long run. However, the best way to accelerate your learning in the early stage is to specialize.
See how to decide which stocks to trade.