The last 2 days of forex market chaos surrounding the CHF and EUR clearly demonstrates the dangers of day trading in the currency markets.
Several big banks like Barclays and Deutsche lost "tens of millions" of dollars and we are only beginning to see the true nature of the currency trading fall out. So if the big banks like Barclays, Deutsche and Citi can get it wrong how could the smaller currency brokers fare considering that they do not have the capital base that large international banks do?
Today, it is estimated that the retail currency market in total makes up about 4 % of the daily global daily spot turnover according to the latest survey from the Bank of International Settlements. That is a very small market share of a global currency market daily estimated at 3 trillion dollars in the spot market alone. Although companies from the retail currency sector like FXCM pose a very limited risk to the overall financial system because they are not banks that trade in huge volumes of currency for import export clients, still when things goes awry it becomes a time for the regulators to turn the spotlight on and address issues that can protect the small time traders from trading currencies in the future.
In the last 15 years brokerages have sprung up offering the public the ability to trade foreign currencies with high leverage and very low transaction costs. The cash FX products became high popular amongst retail customers with under $100,000 US Dollar accounts. Internet marketing enhanced the appeal of the forex trading platforms and the relative ease of account opening led to great popularity.
But now that the dust is finally settling on the SNB's sudden decision to cap the value of the CHF, a host of questions now arise concerning the actual safety of such retail forex trading accounts.
Question 1 - How Big is Big? What does it take in terms of financial size for a brokerage to demonstrate that it has enough liquidity to sustain massive market turmoil and protect the value of it's customer accounts? if FXCM lost a reported $250m and would not have survived without a rescue, then how much more likely could smaller brokerages fold in the face of a liquidity crisis?
Question 2 - In fast moving markets had the customer been made aware of the dangers of entering trades at prices that maybe visible on screen but in effect and reality are far different from that quoted at the moment a trade is placed? Brokerages should be more transparent on how they price their trades. During fast moving markets the temptation becomes much easier to distort pricing and fairness to the account holder.
Question 3 - Do brokerages really explain with clarity to the customer the concept that stop losses cannot guarantee the pricing at which a losing trade will eventually close out? there really needs to be more demonstration of what can go wrong instead of the tiny print disclaimer.
Question 4 - Do brokerages that set their trading prices fully explain to the customer the mechanism whereby they obtain currency in the wider markets and provide a list of their own counter-parties to demonstrate market depth in order to obtain best prices at best efforts at any given moment in time? Obviously a brokerage with several counter-party relationship is faced with more trading options than a brokerage tied to just a few currency providers. Transparency over counter-party relationships would greatly assist a potential customer's decision over opening a new account.
Question 5 - Liquidity? They say that the currency markets are most liquid markets in the world but exactly do we know if our platform providers are liquid enough not to go insolvent during a heated moment? In fairness yes that's certainly true with daily volumes in several trillions US Dollar value. However, in opening a private account with a forex provider, the account holder is usually tied to a single counter-party, being the platform provider itself. So, in reality, the customer doesn't really have a wide array of trading angles like a professional dealer. Hence, the reality of the absence of liquidity, unlike the futures markets where a trader can offload position with relative ease into a liquid market.
We still cannot ascertain the overall damage done to the retail trading sector in the forex market. it's still too early. But damage has been done.
Alpari, the large UK currency broker has folded as a result of massive adverse price movements in forex, and the majority of Alpari account holders had "sustained losses" and will have to go through the painful process of partial recovery of their lost value if at all, through the legal system. New Zealand foreign exchange dealer Global Brokers NZ was also forced as a result of huge losses. Both IG Index and CMC Markets also recorded losses that will affect their customers. Moreover, the popular currency platform provider Denmark's Saxo Bank, one of the biggest players in the forex market, said that it may have to readjust accounts and set different rates for its clients' transactions over the last few days. That indeed is an alarming statement. Saxo Bank chief financial officer Steen Blaafalk told Reuters that some clients had suffered losses and admitted the possibility of litigation should Saxo set different rates.
Indeed these are not good times for the retail currency market providers given that there will be close scrutiny over their trading practices in the months to come.
Conclusion - When trading cash forex in the retail spot market a small trader really needs to do a lot of homework in selecting a platform provider. Forex brokerages are mostly not banks although some may be part of a banking group as in the case of Denmark's Saxo. Certainly forex brokerages and their solvency can become tested under moments of duress as exhibited in the last few days. However, with currency futures products on global exchanges there is far more transparency on the prices of exchange traded products than when trading cash fx products on a private non-exchange related platform. Tighter regulations on exchange-traded products can at the very least, assure a trader of fairer pricing.
Pieter Bergli - DeLoren Trust Holdings
Forex reporting for a better currency markets understanding
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