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Why Retail Forex Trading Will Survive and Thrive

22 Years ago | January 26, 2015 11/27/21, 12:00 AM

The aftermath of the Swiss National Bank shocker that caused so much pain in the forex market has raised questions how this will be impact the retail forex market going forwards. I will address these issues and argue that it should strengthen rather than weaken the industry once the dust settles.


You can compare the Swiss fiasco to an unexpected major earthquake, the likes that has not been seen in recorded history. What do you do then? Do you pack up and leave your home in search of a place where the odds of an earthquake are very small? Do you build a bunker and hide in it? Or do you rebuild but this time with a stronger foundation for your home that can withstand a major shock.

You can also liken it to a flash crash in stocks. Do you stop trading equities in the odd chance this may happen again?  Or do the exchanges take precautions and build in safeguards that would drastically reduce the probability of another flash crash and by doing so, reassure the investing public?

I have been trading in the forex market since I was a young lad in 1974. Except for Nixon floating the dollar in 1972, I have seen just about everything there is to see in this business. I have traded through the oil shock in the 1970s, the silver crisis and Plaza Accord in the 1980s, the collapse of Long-Term Credit Management that saw a massive unwinding of the JPY carry trade, the speculative attack against sterling that drove it out of the ERM, 9/11, the U.S. financial crisis and many other crises or near crises too numerous to mention. Of all these events, one constant was the fluidity of the forex market. There were always prices in the market (even after weekend gaps), which provided liquidity to those trading.

One example is the price action after the ECB announced quantitative easing at the January 22 meeting. This turned out to be a major market moving event with the EURUSD falling from a high of 1.1651 prior to the announcement to a low of 1.1335 following it.  (-2.7%). On January 23, that low was extended to 1.1115, a 4.8% decline from the high for the week at 1.1680 set on January 21. This may not seem like a big move for equity traders but in the world of foreign exchange, it was a very large move in a major currency over a short period of time. By comparison, the average daily EURUSD range over the past 30 and 90 days has been around 0.9%. What is important to note is that the EURUSD decline (and movement in all currencies) was orderly, no gaps and prices to trade available at every level. This is more the norm for the forex market than after the SNB pulled the floor out of EURCHF, sending the CHF surging vs. all currencies and creating the equivalent of a flash crash.

Why this was unpredictable is that it was caused by a central bank that acted in a reckless and amateurish way. The SNB gave no notice to other central banks so they could not prepare for the volatility. It did not notify the IMF, which was furious over not being told in advance and publically chastised the Swiss National Bank. Central banks react when there are disorderly markets and this fiasco should make them more aware of their actions in the future. It also argues against a major currency being pegged in the future the way the SNB had set an floor under EURCHF.

I have called this a once in a lifetime event and I stick by that statement. As I said, I have just about seen it all and doubt we will see this again in my or your lifetime. It is like the unexpected earthquake of major proportions. The forex market will rebuild and strengthen its safeguards against anything close to this happening again.

So the question from here is how will this affect the retail forex market?

1)    Retail forex is a viable business that will continue in the future. There is an irrefutable need for an active and liquid forex market for trade, investment flows, business and government finance. This is far and away the largest financial market in the world (daily volume = USD 5tn), and speculators provide needed depth and liquidity to the markets. Retail forex will continue to thrive and adapt. This is an ideal time for a credible player to enter into the market to provide structure, safety and stability.

2)    The broker (and institutional) market will be more cognizant of downside risks and will be quicker to adjust margins when volatility or risks suggest to do so. Customers have become a lot more aware of the risks and are already moving their accounts to brokers they feel employ sound financial practices. In this sense, the market has become self-policing

3)    There is a question whether leverage will be lowered and how that would affect the retail forex industry. One may argue that this is overdue, especially by those brokers who offer high leverage (e.g. 200:1 and more). Even 100:1 seems high but it remains to be seen if that will be lowered (U.S.leverage is currently set at 50:1). One can also argue that lower leverage is good for business as traders will be more likely to stay in the game for longer rather than trading with high leverage that increases the risk of blowing their accounts sooner. This could help maintain volume as more traders staying in the market trading longer would make up for lost volume from those trading with excessive leverage who risk losing their equity from poor money management.

4)    There is a question whether countries like the U.S.will overreact to the SNB fiasco and cut leverage to the point that it drives traders away from retail forex trading. The argument against this is that over the counter forex margins should be the same as those that exist in the futures market. The risks are the same and so should be the margins.  The CME has a strong interest to support its currency futures trading and will likely lobby against reducing leverage to a point that would cripple its business. As noted, margins should be based on volatility and adjusted to reflect current risks. In addition, even if leverage is lowered outside the U.S., it would likely still be at a level that attracts traders to the market.

5)    While the pain caused by the CHF flash crash has yet to be fully told, FXCM is being used as the poster boy for what could go wrong. However, the full story here is not clear as other U.S.forex firms, such as Gain Capital and Oanda did not suffer such crushing losses. In fact, both have forgiven negative customer balances, which suggests that they did not suffer the same fate as FXCM. So until the full story on FXCM comes out, we cannot determine whether there were other factors that contributed to its losses that led to a rescue loan to keep it from going under.

What also is worth noting is that except for Alpari (which immediately declared insolvency, suggesting there were probably other factors behind such a quick decision) and a small NZ broker, there have not been any reports of brokers being forced to shut down. I am not saying that there were not significant losses but the retail forex market is still standing. It may say something for risk management protocols that allowed many firms to get through this difficult time, even make money on the volatility.

To sum up, if you think about my earthquake analogy, the retail forex broker market will look to strengthen safeguards to protect it in the future.  Whether this happens as a natural consequence or through regulation or a combination doesn’t matter. What matters is that it is coming (I prefer self-regulation) and that makes me more confident now that I was before the SNB shocker that the retail forex trading business will not only survive but will thrive as a viable business.

 

Jay Meisler, founder

Global Traders Assocaition

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