by Vadim Pokhlebkin
Updated: November 03, 2017
The average daily trading volume in foreign exchange is more than $5 TRILLION. EWI's currencies expert, Jim Martens, discusses the pros and cons of trading forex vs. trading stocks.
Vadim Pokhlebkin: Jim, many readers of elliottwave.com tell us that they want to make money trading the markets. Would-be speculators have lots of options. Your area is forex -- the market which has been growing by leaps and bounds. Can you explain why I'd want to look at forex and not, say, the more "traditional" stock trading?
Jim Martens: A few reasons are immediately obvious.
1. Liquidity. Currency markets are much larger than equity markets. By most estimates, the daily volume in forex is as much as 10 times larger than the combined volume of ALL of the world's stock markets. That makes it a very liquid market.
2. 24-hour-a-day trading. We are also talking about a market that trades around the clock. That means that if you are a short-term trader and the price spikes after hours, you can adjust your existing position or enter a new one without having to wait until the market reopens the next morning. Sometimes you can do that with stocks too, but typically the spreads (the bid/ask) in stocks after hours widen out, so you may have to pay extra to buy a stock that, for example, announced great earnings after the close of the stock exchange at 4 PM.
That's not the case with forex. Liquidity stays plenty deep for most investors around the clock. Yes, there are moments when currencies are less liquid, but for most participants, liquidity is fine even then. Spreads stay tight, too -- for example, for the euro-dollar exchange rate, or EUR/USD, they are typically 2 pips (points) or less, and they may go to 3 pips when liquidity is not as high. But rarely do we ever see a major widening in spreads.
3. Manageable number of trading choices. I think the ease of choosing a currency to trade is also a big advantage. How many stocks now trade around the world? Between the U.S., European and Asian stock markets, there are at least 40 industries, each with a number of sub-industries, and each one of those with 100+ stocks. So we're talking about tens of thousands of stocks -- and you have to choose the right one! Even in bull markets, while "the rising tide lifts all boats," as the saying goes, it may not lift your particular "boat" -- in fact, your stock may even decline if it's not the best stock in its peer group, or if you're in the wrong sector. Often, you see your sector or stock fall even as the general market rises, so you have to be very good -- or lucky -- at your stock picks.
The currency market has far fewer choices, and it's a good thing, because that makes your job much easier. Most forex traders stick to the major pairs; in fact, the bulk of trading is between the U.S. dollar and euro -- by some estimates, up to 70% of the total daily volume. Besides EUR/USD, we have 5 or 6 other major pairs -- and by watching those, you are basically watching the entire world. In EWI's Currency Pro Service, we track and forecast 11 most popular forex pairs, plus the U.S. Dollar Index.
Of course, you could expand your forex trading into cross rates -- those are non-U.S.-dollar currency pairs, like EUR/GBP, for example. But even then we're still talking about maybe two dozen most active markets versus tens of thousands of stocks. So currencies are just easier to follow in that regard.
4. Limited impact of financial news. Here is another advantage of trading forex. When you trade individual stocks, financial news plays a much bigger role: sector news, individual stock news like earnings, etc. With currencies, we focus on "the big story" instead. There are big economic data releases coming out of each country every week, but we watch economic data calendars and know when they are coming out -- and they rarely surprise us. Instead, we spend more time watching forex markets' technical indicators like Elliott wave patterns, momentum like RSI or MACD, Fibonacci price targets, and so on.
5. Easy long, easy short. Forex offers you the flexibility to go long and short with ease -- something that stocks just don't. When the broad stock market declines, most people are uncomfortable selling short -- that is, selling a stock they don't own in hopes of buying it back later, returning it at a lower price and capturing the spread. Most investors just don't do that, even with some new avenues for doing so that became open in recent years: mutual funds, ETFs, etc.
In forex, it's a whole different story. Whenever we quote a currency market -- take EUR/USD, again -- we are comparing one currency against the other; we are tracking the value of the euro against the value of the dollar. So even when we are selling one market, we are always buying another! We are always buying the base currency, which is the first one in name of the pair. In EUR/USD, the base currency is the euro. On the other hand, in dollar-Swiss franc (or USD/CHF) we track the value of the dollar relative to franc; the dollar is the base.
6. Volatility and trend-following. Forex markets have lots of volatility, too -- good for aggressive traders. And if you're a macro-trader, currencies are well-known for staying with the trend for a long time, too. Volatile at times, yes, but steadily trending.
So, there are several reasons why one might look at forex versus stocks.
VP: I've seen online ads that say, "Trading forex is easy." Do you think it's easy?
JM: Well, I'd go back to the first question you asked me. Easy? No. Easi-er than equities? Yes. In forex, there are fewer markets, so you have fewer choices and less news to be concerned with -- so, fewer surprises.
Our main goal is to find the one currency that looks the strongest against others, and one that looks the weakest. Found them -- now pair them together. Sounds easy, but in practice, keep in mind that when trading ANY vehicle, we are trying to predict the future, and that's a hard task. It's especially hard with individual equities, because you need a real system of how to approach first the broad market, then the sectors, then your stocks. That's why Wall Street investment houses have hundreds of equity analysts -- and maybe five technicians, the analysts who, like us at Elliott Wave International, focus on the markets' technical picture.
That's also why a lot more forex traders use technical analysis than equity traders. But winning is hard in both markets.
As a technical trader, you can only control one thing when it comes to the future: How many viable chart pattern possibilities there are. Elliott wave analysis allows us to limit those down to a handful, and rank them in terms of their probability. That's a great advantage, but at the end of the day, trading is trading, so the requirements are the same:
VP: In your Currency Pro Service, you forecast forex using Elliott wave analysis. Why Elliott? Why not just watch the news and trade forex around the major economic report releases?
JM: Yes, you should pay attention to the news! But relying solely on the news will get you into trouble.
For example, let's say the Federal Reserve raises interest rates. Will the dollar soar or fall? Using fundamental analysis, you can argue for both scenarios:
Scenario 1: Higher interest rates are bullish for the U.S. dollar because it means the Fed thinks the U.S. economy is getting stronger.
Scenario 2: Higher interest rates are bearish for the U.S. dollar because they make borrowing more expensive, and that slows the economy.
See? Same news, opposite interpretations -- yet each one perfectly logical.
With Elliott wave analysis, you don't have that. You know what the larger Elliott wave pattern is, so regardless of the news-driven volatility, you know the larger trend. Which means that you can remain objective and not confuse yourself with the hour-by-hour news and fundamentals.
In my work, I do follow the news -- I just use it differently. As technicians, we already know, based on chart patterns, where the market should go. We look at its reaction to the news and see how it fits into the Elliott wave pattern. Many traders shy away from taking risks around big news events, and I don't blame them, because volatility can be tremendous. But we've had some good success over the years at forecasting the markets before a big news report -- because we already know the larger trend! If wave patterns show a clear bullish or bearish setup in front of the news, we've often been able to use the subsequent volatility to our advantage.
Besides that, why do I use Elliott wave analysis, in general? It just fits my personality.
VP: How did you learn Elliott? How long was it before you were able to make confident forecasts? Where should one start with applying Elliott wave analysis to forex?
JM: About 30 years ago, in mid-1980s, I first saw Robert Prechter, EWI's president, on TV. He had quite a following and was on almost every week. I watched his forecasts come true, for the most part; that certainly gets your attention. As many people did, I ordered his book, "Elliott Wave Principle -- Key to Market Behavior," read it, and that was it.
The first 2 chapters tell you everything you need to know. It's not an easy read; you do have to stop and think. (Lots of pictures, though!) There is really not a wasted word in those 70-some pages. It took me several readings, and even now I go back and re-read them every once in a while.
I started, like most people, by applying Elliott wave analysis to equities, but after joining EWI in 1993, I've applied it to virtually every market we cover (about 60 of them, give or take), in all time frames. So I've seen it work in every situation.
How long did it take to learn it? Well, I never stopped! I often watch Prechter's old videos on applying Elliott wave in practice. And I take the same approach with my subscribers. Every Friday, I record a 5-6 minute video where I explain our latest forecasts or a new opportunity and also include an educational component, often about the basics. Learning the basics well will help you a lot.
So, if you're a forex trader interested in Elliott, you start with Bob's book, you watch my weekly videos, and then you progress to label your own charts. Over the years, I've seen that the most successful forex traders are not those who blindly follow forecasts. It's those traders who do their homework, who do their own analysis, Elliott wave or something else. They think for themselves, and when they put on a trade, it's because they have their own conclusions. Once they've done that, then they look to see what our forecasts are saying. If we agree on the trend, they have greater confidence. If we disagree, then the real work begins. Why do we disagree?
That brings up another important point. Some say it's confusing that you may sometimes have a couple of different Elliott wave interpretations of the same price move. But the real question is, do they point in the same direction? If so, that's not confusing, it's a confirmation!
Those subscribers who do their own Elliott, as long as their wave counts and mine give at least a common price target and stop-loss level, they can go ahead and act anyway. The market will eventually decide which Elliott wave count is right -- but if the trend is clear, go with it. That's how I use wave analysis.
VP: Thank you for your engaging answers, Jim.
JM: My pleasure.