Pros and Cons of Asset Classes
|Hello traders! Recently I received an email from an Online Trading Academy student from Arizona. The question was about which asset class to trade next. While you might think my answer would be automatic: forex of course! The real answer is a bit more complicated. This week I’d like to break down the basic differences, including pros and cons of the different asset classes, so future students can make a better informed decision. Off we go!
When having this discussion in a classroom I always start with equities (stocks). The reason for this is that most people are already a little familiar with the stock market. So here (in my humble opinion) are the pros and cons of trading stocks.
Pros of Trading Stocks:
Stocks are easy! Because the two underlying emotions in trading, fear and greed, are so easily visible on stock charts, to me this is the easiest asset class to trade. The main reason for this seems to be that so many retail traders trade stocks, and so many of them do the wrong thing in the market, the mistakes are obvious. (This could lead to a long winded commentary on hedge funds, how they are mostly run by very bad traders who just chase momentum stocks, soaking their clients for huge fees and underperforming the S&P 500; but it won’t.) In the following chart of MSFT I’ve marked two areas where fear and greed took over the rational traders’ decision. Buying AFTER a large run up into supply is greed, and selling AFTER a large drop into demand is fear.
Cons of Stock Trading:
Trading stocks is expensive! By this I mean that the leverage in the stock market is very small. In a margin account your broker will usually offer you a 2:1 leverage, you put up $50,000, and you can actually buy $100,000 worth of stock. Hurray, using Other People’s Money to make money! With a day trading account, the broker can offer you 4:1. Even better! However, be aware that with higher leverage also comes higher risk.
Bottom line: stocks are easy, but expensive.
The next asset class is futures.
Pros of Futures Trading:
Better leverage! This asset class is a little harder to define the actual leverage being offered. For basics, we’ll just say that it ranges from about 10:1 to about 40:1. In the futures market, you can also trade things like gold, oil, wheat and even the S&P 500. Plus, many futures contracts offer almost 24 hour a day trading! Who wants to trade at 10pm or 4am or 11am? I know I do.
Cons of Trading Futures:
My belief is that the “quality” of traders you are competing against is a bit higher than in stocks. Stiffer competition means slightly more difficult trading. However, it isn’t like moving from sandlot baseball to playing against the New York Yankees! Another con is the fact that futures have a few more rules/things to know, like expiration dates, rollover, some contracts trade different times of the day than others.
Bottom line: Futures offer better leverage and more times of the day to trade, but they are a bit more complicated than plain old stock trading.
The third asset class we’ll discuss is forex.
Pros of Forex Trading:
Great leverage! Generally we can get anywhere from 20-50:1 for United States based traders. We also have 24 hour trading, starting Sunday afternoon and going all the way to Friday afternoon. In forex, we only really have a couple dozen different currency pairs to trade, where stocks have literally thousands to choose from. One of the best things about trading forex is that you can start trading very small. You can actually take trades where your risk amount is pennies. Wouldn’t it be nice to learn to trade where the most you can lose is $1?
Cons of Trading Forex:
Because forex is what we call a de-centralized market (there isn’t one place where all the trades and quotes are reported), different brokers will often show slightly different prices. Consequently, their charts will be slightly different as well. This can lead to more losses for the short term breakout trader.
Bottom line: Great leverage and 24 hour trading are terrific, but small time frame traders can often do poorly because of the de-centralized market.
Last but not least, options. I love options!
Pros of Options Trading:
Options offer higher leverage than stocks; you can trade options on individual stocks where you can still take advantage of the fear and greed on the charts, thereby taking the good stuff from stocks and eliminating one of the cons. With the right option strategies, you can even make money when the market doesn’t move. Another good thing about options is that you can be “less precise” with your entries. Instead of buying in a quality demand zone and selling in a quality supply zone, you can place option trades where your chosen stock isn’t likely to go. Nice and vague, right?
Cons of Trading Options:
Options have an entirely new language to learn. Many new students come to Online Trading Academy with a bit of experience in the world of trading. They use terms like “support” and “resistance”. We prefer demand and supply, among others. These terms translate easily from stocks to futures to forex. In the options market you will learn many new terms like “time decay” and “open interest” to name a couple. For those of you who like math and numbers, options would probably be a great asset class to trade. For those of you who don’t, focusing on the “easier” option strategies can certainly make you money as well.
Bottom line: Options offer you tons of versatility, but also a bit more complication.
There you have it, traders, a basic, 10,000 foot overview into the pros and cons of the different asset classes! Always talk to your Online Trading Academy Education Counselor to help figure out what will be the best for your personality and financial situation.
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