What You Need To Know About The Relationship Between Stocks And Forex
Before we jump into stocks and forex, we need to deal with the elephant in the room: inflation in the U.S. economy.
While countries around the world are dealing with similar issues, U.S. inflation is a particularly dangerous beast. The Guardian reports that inflation is at 9.1% YoY, which is a 40-year high. As the price of gas, groceries, and even real estate fluctuates, investors find themselves reluctant to pour money into a teetering economy.
It’s not all bad news, however as the Federal Reserve is pulling out all the stops and raising interest rates in order to combat inflation – and we hope it works. This may be a good short-term solution, but having high interest rates and soaring inflation over a long period of time could edge the U.S. into a recession.
Investors, on the other hand, have an important role to play in this type of economy – as more money is invested and moved in currencies together (or against) the U.S. dollar, the economy should stabilize somewhat. This is where both stocks and forex trading come in.
Are there any other similarities between stocks and forex that can give stock investors an even bigger edge?
What's the difference between stocks and forex?
Stocks are equities that investors buy. In order words, once you buy stock in a specific company, you essentially own a piece of that company. The objective here is to invest in companies that will do well in the next few months to years, increasing the value of their stocks. The investor can then turn around and sell that stock for more than they originally paid for it.
Forex, or foreign exchange, is the trading market for currencies all around the world. Investors deal with currency pairs – or currencies pinned against each other – to see which currencies will gain value. This happens at a much faster rate than with traditional stocks. Many investors will sit on stocks for years, while forex traders are known to trade currency that was bought the day prior. The main similarity they have is that global news can affect the value of both stocks and currencies potentially in a matter of minutes. For example, this article from CNN explains the current 1-cent difference from parity between the euro and the U.S. dollar and what it means for investors.
How are stocks and forex related?
It seems that on average, the stronger a country’s local stock market is, the better its currency will be. Of course, this isn’t true for every country, but it’s a pretty good rule of thumb to follow. In part, this is why FXCM's volatility chart displays stock prices alongside currency values. If investors who deal with both stocks and forex are well informed about the value of each, they can make informed decisions and educated forecasts about what their chosen currency will do in the following days or weeks.
It’s also important to know what industry a country’s currency is linked to. For example, Peru’s economy is strongly linked to tourism and hospitality. In 2018, a cool 4.42 million tourists visited the country, according to Statista, which means that its currency, the Peruvian New Sol, was stronger at that time. During the pandemic when tourism was at an all-time low, the PEN was devalued against the USD, which was great news for whoever had some spare dollars to sell and Peruvian currency to buy.
How can stock investors use this information?
Essentially, they can use it to determine the profitability of a company. The basic idea is that stock investors should invest in a company’s stock when its domestic currency is weak, and its market’s currency is strong. This way, the company – and indirectly, the investor – will get a better return. On the other hand, Using forex to gauge the viability of a stock can help investors avoid stocks that are rising just because of public speculation, as explained in our previous article on “5 Common Mistakes”. Understanding a country’s currency as well as stocks can help investors discern which stocks are rising simply because of recent news, and which ones are strong because of their country’s economy.
Investing in the stock market is non-trivial, specially in this volatile and unpredictable environment. So, before making any investment, consider seeking guidance from our team, with our established record of market crushing returns with our solid, long term investment strategy.
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