Has the CHF Fallout Broken the Forex Industry?

At the moment, it's a low point for the fledgling FX industry, but from adversity comes opportunity.

I run a prominent forex company and believe there needs to be a better understanding of what occurred than what is portrayed in the headlines. It implies that someone made money in the markets, just not the brokers, and the brokers were caught with their britches down.

The only people I know of that won are the sharp bankers, who are my friends, and like to tell me that retail forex is for losers while dropping $1,000 in a casino. At the moment, it’s a low point for the fledgling forex industry, but – like trading – from adversity comes opportunity. Moreover, I wish to point out how both the trader and the broker can profit on a sustainable basis as market uncertainty rises.

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It may be fun to see a 40% drop in a currency, as long as it doesn’t happen to you, but the current pricing and leverage in the industry does not match current market conditions where volatility has been at decade lows. It is very painful to anyone that took on a liquid contract with 100:1 leverage. In one moment, the loss is magnified 4,000 times (40×100). Most traders that I have observed were short the Swiss franc. So it was the traders with the brokers backing their trades that lost the funds. Remember it was the losers that cost these brokers their business, not the winners.

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The main problem is that online forex brokers do not pass on the liability to their customers. As a result, the broker has to eat those losses. When a broker is a Market Maker, there is no real cost involved. But the new fashion in forex is to offer an agency model where each and every trade is placed into the interbank market – in addition to the very large expense of maintaining regulation. So the broker now, against his better judgment, places one sided trades on behalf of clients with large leverage (up to 200:1), at a very small commission (it’s online after all) while taking on all the risk. Many of these clients are also beginners and building up experience.

At the end of the day, offering an agency model is the best solution as it avoids most conflicts, except encouraging overtrading which generates commissions. I believe that brokers will have to spend more time educating traders about trading on lower leverage while taking a larger commission. So while liability is still on the brokers shoulders, the larger commission and education of traders should give them better tools to focus on low-risk profitable trades for the longer term.

But until this is more accepted by the mainstream, a good healthy market maker is what is needed for all kinds of traders as volatility is set to increase and allow the broker to setup his exposure as deemed appropriate.

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