Think Twice Before Trading Currencies

Jan 20, 2015   //   by Profitly   //   Market, News, Profitly  //  Comments Off on Think Twice Before Trading Currencies

So you want to trade currencies? A lot of people have tried to take up currency trading as a way to boost returns with interest rates so low and the stock market near record territory. A lot of these same people got absolutely crushed last week in a central bank shocker. Even financial titans like Deutsche Bank, Barclays, and others like FXCM saw massive losses. So, you may want to think twice before diving in to this volatile market.

Speaking of FXCM, the stock is getting crushed, falling more than 80%. What exactly is FXCM? It’s a currency-trading platform for mom-and-pop investors, and on Thursday they revealed that their clients had taken a massive hit when the Swiss central bank surprised the world and abandoned its efforts to create a ceiling for its currency. There are a few things to keep in mind here. First, note that they are mom and pop investors rather than sophisticated traders. Secondly, according to the Wall Street Journal, about two-third of FXCM’s U.S. clients lose money each quarter. In last year’s third quarter, the most recent available, 68% of the firm’s active U.S. accounts were unprofitable.

Does this mean that FXCM just has really dumb clients? No, it means that trading currencies is hard. The two-thirds figure holds true across much of the industry. Among six of the biggest firms that allow U.S. retail traders to play in the currency market, a weighted average of 38.3% were profitable, according to Forex Magnates. In other words, more than six in ten were unprofitable.

Here’s the third-quarter 2014 data from Forex Magnates in chart form:

Via WSJ

Via WSJ

It’s the smallest and the newest investors that are most likely to lose money. It is safe to assume that this is likely because they are the less experienced and haven’t had  a change to burn out yet. The firms with the highest percentage of profitable accounts, Interactive Brokers and CitiFX, have minimum deposit requirements of $10,000. For some of the others, the minimum is much lower–as little as $50. The average account in the U.S. has about $6,000 to $7,000 on deposit, according to industry research.

Even with just a few hundred dollars in an account, the forex firms allow their customers to employ leverage to increase the size of their bets. A $1,000 account can make a $50,000 trade. But that also creates a problem: it’s easier to wash out entirely. So the would-be traders that come in, set up an account, lose all their money and never return–all in the span of a single quarter–are only counted as “unprofitable accounts” once.

Still want to trade currencies? Then learn from these Business Insider posts below.

More than three years of stability between the euro and Swiss franc just ended suddenly, as the Swiss central bank abandoned attempts to cap the currency’s value.

The bank previously aimed to let the franc rise no higher than 1.20 to the euro (about €0.83 to each franc). As soon as the change was announced, it smashed immediately higher, breaking through the previous “ceiling”. It broke through a 1:1 exchange rate, surging above €1.10.

Here’s the euro plunging against the franc, down by nearly 28% as the news broke, an astonishing move for a currency:

swiss franc.png

Moves like these occasionally come from countries like Russia, where a drop in a commodity they produce tanks, but they’re almost unheard of in the major advanced economies. As of 1:00 p.m. GMT (8:00 a.m. ET), the euro is down by more like 14.6%, to just 1.026 Swiss francs.

Switzerland brought the currency cap in 2011, to put a halt to the constant appreciation of its currency. The franc is seen as a particularly strong and safe currency, and saw huge inflows during the worst years of the euro crisis.

This is likely to have a big impact on a lot of Europeans: For example, if you’ve got a mortgage denominated in Swiss francs, but you get paid in euros, it just got a lot more expensive. On the other hand, if you’re getting paid in Swiss francs, that holiday to Italy suddenly looks a lot cheaper.

According to the Swiss National Bank’s statement, it was just becoming too difficult to justify the currency ceiling:

The euro has depreciated considerably against the US dollar and this, in turn, has caused the Swiss franc to weaken against the US dollar.

In these circumstances, the SNB concluded that enforcing and maintaining the minimum exchange rate for the Swiss franc against the euro is no longer justified.

As the dust settled from Thursday’s surprise decision to unpeg the Swiss franc from the euro — which blasted the franc up higher — we’re beginning to see the damage that was done.

According to the Wall Street Journal, Detusche Bank lost $150 million on the move. The Journal also reported that Barclays lost tens of millions.

It was expected that smaller businesses would feel the pain of this sudden, volatile shift. Business Insider’s Mike Bird reported that UK-based FX broker Alpari just announced that is has entered insolvency.

From Alpari’s announcement:

The recent move on the Swiss franc caused by the Swiss National Bank’s unexpected policy reversal of capping the Swiss franc against the euro has resulted in exceptional volatility and extreme lack of liquidity. This has resulted in the majority of clients sustaining losses which has exceeded their account equity. Where a client cannot cover this loss, it is passed on to us. This has forced Alpari (UK) Limited to confirm today, 16/01/15, that it has entered into insolvency.

Casualties continued to roll in. Foreign-exchange brokers who had relied on the stability of the Swiss franc, which until Wednesday was pegged to the euro, were taken by surprise when the Swiss National Bank abolished its controls, and millions of dollars were lost at firms around the world.

The UK-based FX broker Alpari just announced it had entered insolvency. Here’s what it said:

The recent move on the Swiss franc caused by the Swiss National Bank’s unexpected policy reversal of capping the Swiss franc against the euro has resulted in exceptional volatility and extreme lack of liquidity. This has resulted in the majority of clients sustaining losses which has exceeded their account equity. Where a client cannot cover this loss, it is passed on to us. This has forced Alpari (UK) Limited to confirm today, 16/01/15, that it has entered into insolvency.

That follows New Zealand’s Excel Markets, which made the same statement earlier, according to the Financial Times.

Brokers can go out of business on big moves like this because they give their clients access to leverage. For example, an account holder might have $1,000 with the broker but hold positions worth $10,000 in currency markets. That doesn’t matter so long as the holder’s losses are covered by the initial amount. But Wednesday, for at least two brokers, that wasn’t the case for a lot of those clients.

The New York-based FXCM, one of the world’s biggest foreign-exchange brokers, says it may be in breach of rules on capital requirements and that it is owed $225 million by clients who are now in negative equity. FXCM shares are down by an astonishing 90% ahead of the US open.

IG Group, a publicly listed UK-based broker said Thursday that its losses would not exceed £30 million ($45.7 million).

This isn’t likely to be the last of the fallout from the colossal move, which was almost unheard of among the most widely traded currencies of advanced economies. Here’s what Thursday’s fluctuation looked like:

swiss franc 2

Just like Tim and the other gurus teach you how to trade penny stocks and follow chart patterns, reach SEC filings, etc…you need to learn the fundamentals of currency trading before even thinking about diving into that market.  If these professional Wall Street firms (we use the word professional loosely there) are losing millions on this, think about how poorly the uneducated trader is doing.