Is the Forex Industry Growing Up?

Currency trading has a well-deserved reputation as being the “Wild West” of financial markets, but it doesn't have to stay

Every bastion of civilization that we look upon today has evolved from a primitive, dark place.  It is through progressive thinking, applying constructive pressure, and always raising the standard, that humankind’s abilities and institutions are as amazing as they are today.

The Forex market is interesting in this respect.  Despite being one of the oldest forms of trading (only bartering is older!), its mysterious waters are still murky.  Allowable leverage is abnormally high, market adoption of Forex in the US is low, and poor broker risk management practices are rampant.  That has changed enormously over the past few years, and I believe that the uptrend in both transparency and accountability will continue, as the Forex industry collectively learns its lessons.

The first major Copernican shift in perspective was the advent of “No Dealing Desk” execution – though to be frank the real disruptor was ‘using any kind of execution in which the broker doesn’t directly prey on its clients’.  Over a short period of time starting in 2007, retail Forex traders’ eyes started to open, and with the backing of a major broker, the word got out that Forex is not your granddaddy’s stock market yet, but was getting there.  A growing subset of traders demanded transparency in execution policies from their brokers, and their voice has grown louder over time.

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In 2010, after the battle between “Dealing Desk” and “No Dealing Desk” was already underway, the Dodd-Frank act ushered in another new era, limiting leverage in the US to 50:1.  Of course, retail traders balked at ‘not being able to get any decent leverage’, as one trader told me while I was his broker at FXCM.  But, as we do with children — pulling them kicking and screaming through the painful process of growing up — retail traders need a wise hand to save them from themselves.

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I would always ask my clients who complained about not getting more than 50:1 leverage, if they have a track record of profitable trading at all, with any degree of leverage, such as 20:1.  Not once did someone answer “yes” – meaning that, if any more leverage was applied, their losses would have been even greater.  It wasn’t a nice thing to ask, but it did get people thinking about whether they knew what they really wanted.  The recent tumble in the EURCHF has reinforced the benefits of not overleveraging your account.

So then, why does nobody think to ask for more leverage in the stock market?  Because multiple crashes over the previous decades have reminded us that 2:1 is plenty of equities leverage already, if not overkill.  It’s part of the industry, and common knowledge, that day-trading stocks is risky and not to be taken lightly.  Instead, most investors use less leverage, and invest for the long term in companies they believe in.

This is how Forex must evolve.  It must transform itself from ‘a tool for risk-hungry gamblers to get their fix’, into a normal part of any savvy investor’s portfolio.  Encouraging lower leverage, establishing partnerships with stock brokers, and even introducing ‘actively-managed Forex ETFs’ that can be traded on the securities markets will help.  FXCM’s IB relationship with E*Trade FX is a good example of this, and similar deals should be struck.

Sure, you can’t fund your Forex account with a credit card anymore – but nobody talks about making a deposit to their equities account with borrowed money, so please – get with the program!  Retail traders will rarely do what’s actually best for them unless a market leader educates them on the best way to participate in currencies, and so we must continue to press and call upon these Forex industry leaders to be more transparent, more legitimate, and help the industry become a little bit more like your granddaddy’s stock market.  Additional reductions in maximum leverage, giving brokers guidance in establishing risk-management policies, and putting emphasis into further integrations with stock brokers, will all help the industry evolve in a positive direction.  May the Forex be with you.

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