Forex trading has become increasingly popular in recent years. With improving technology and the availability of spread betting and CFD platforms, a number of private investors have been attracted to the potential to earn significant returns in a relatively short space of time.
The problem, though, is that forex trading can be risky due in part to its volatility, as well as the fact that many investors use leverage through CFDs or spread betting. As such, investing in shares through tax-efficient accounts such as an ISA could prove to be a better means of long-term wealth generation.
Risky business While the idea of potentially making a quick, and substantial, profit from forex trading may be appealing, the reality is that forex markets often move rapidly, and somewhat randomly, over the short run. Even looking at a variety of technical and fundamental indicators can lead to poor decision-making by investors. And, should the market move against them, they can lose significant sums of money in a short space of time.
Since leverage is often used to trade forex, an investor can see their losses mount up very quickly. Due to the volatility of forex markets, they may even lose more than their initial investment. As such, it could be argued that it is more akin to gambling, rather than seeking to invest in businesses that add value in one way or another.
Stock market investing By contrast, buying shares can prove to be a far less risky endeavour. Although the stock market may be volatile at times, over the long run its general direction of movement has been upwards.
For example, the FTSE 250 has recorded an annualised total return of over 9% in the last 20 years. While that may not sound like a significant return to someone who is aiming to double their money in a short space of time, even modest investments can end up being worth significant sums of money when compounding is allowed to have its full effect. For example, £500 per month invested in the FTSE 250 earning 9% per annum could be worth over £300,000 after 20 years.
Risk/reward Certainly, investing in the stock market may be less exciting than forex trading. Many listed companies may not offer the same level of volatility as currency trading. As such, their return potential may be lower. At the same time, though, the risk of loss appears to be significantly reduced, with a portfolio of shares in high-quality companies seemingly likely to deliver high returns in the long run.
As such, for individuals who are seeking to increase their wealth over the long run, the tried-and-tested method of buying shares and then reinvesting income received could be a sound choice. Otherwise, it is all too easy to lose significant sums on currencies which, in the short run at least, may be subject to random movements in price that are impossible to accurately predict on a consistent basis.
Motley Fool UK 2019