Excessively High Leverage Continues to Haunt the Forex Industry

Three months after the SNB, retail foreign exchange is back where it was as companies continue generous leverage offerings

One would think that after several weeks of deliberations about risk management, negative balances, crises and disasters, the foreign exchange (FX) industry could have come out stronger from the black swan event which roiled the industry on January 15th, 2015.

Unfortunately, after a few weeks of shortsighted deliberations and caution prompted by the Swiss National Bank’s (SNB) move, for a big chunk of the retail FX industry things are looking to move back to normal. Despite numerous limitations to leverage, especially in the Swiss franc pairs, in many cases we are now seeing those pairs’  leverage revert to previous levels.

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a number of outfits have proudly announced that they are again offering up to 1:2000

A number of outfits have proudly announced that they are again offering up to 1:2000, 1:666 or 1:888 leverage. As eye-catching as these numbers should be, they also provide an insight into the business model of a number of businesses, which really don’t care what happens to this industry in the long run.

What Will Happen in the Long Run?

Short-term thinking continues to dominate the market. Ironically, this is precisely the same approach that most retail investors taking advantage of those generous leverage and bonus offers are implementing. Eventually, there is no reason to believe that the end game won’t be the same – however, unfortunately for the rest of the industry, there will be collateral damage.

it’s not only about customers losing their deposits and moving away from the industry, but also about these same customers advising their friends to stay away from FX altogether

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Retail traders will eventually begin and continue thinking that all a brokerage does is “rip” them off, which in some cases has indeed been a stark reality. However, there is still a big chunk of this industry that includes both market-making and straight-through processing (STP) brokers, who are acting responsibly towards their clients.

Certain firms have started realizing that in order for this industry to continue growing and be successful, their clients need to begin making money. Yet the issue goes deeper, as it’s not only about customers losing their deposits and moving away from the industry, but also about these same customers advising their friends to stay away from FX altogether.

Inevitably, as the number of retail investors who lose money in FX continues growing, the attention of the regulators will key in on the industry and impose additional and potentially stifling measures in order to tackle the excessive risks that customers are willingly or unwillingly taking.

It takes a short glimpse into history to see how the regulatory regime has acted in similar conditions.

Despite being slow out of the gate, regulators are notorious for overzealously wiping out half of the industry with a number of compliance measures, i.e. Dodd-Frank in the U.S. A simple look at the profitability per million in Japan and the number of retail FX brokers in the U.S. sheds light where the industry may go if its current trajectory continues unabated.

Albeit the call of many FX industry insiders asking the market to stay together and respond to the SNB crisis as one, no such action occurred. Just like the day after the SNB shock, brokers simply went back to their “business as usual” mode of operation – indeed, the industry has ultimately failed to come together and address some critical challenges… for now.

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