Brokers will keep facing challenges in both good times and bad, regardless of volatility. Throughout the past year we have seen both sides of the coin. Record lows in foreign exchange market moves in the first seven months of 2014 and the return of rampant volatility culminating in the decision of the Swiss National Bank to drop its exchange rate floor for the EUR/CHF pair.
While on the surface and in hindsight there are many ways in which a broker is able to protect itself against the perils of low and high volatility, there is an argument about the predictability of black swan events.
Black Swans are Always Lurking Around the Corner
Some industry insiders boldly say that everything should be expected, others claim that unexpected events are just that – nobody can accurately predict whether those will occur or, more importantly, when.
There has been a slew of investors which have predicted the black swan event of the EUR/CHF floor drop, just as there have been many who profited from the subprime lending bust and the inevitable collapse of the most leveraged bank on Wall Street, Lehman Brothers.
As the joke across the industry went, the Swiss National Bank’s floor has been held by retail traders. Yet the brokers turned out not to be insulated from their traders. Why?
Revamping Risk Management
It’s time for the risk management departments at brokers to get busy, or for firms to start outsourcing the process to qualified professionals. Having a simple monitoring desk which is composed of inexperienced graduates or professionals who have no clue about the market is not an option.
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Making assumptions about risk management is a disastrous practice, and brokers who do not care about markets and only focus on marketing will not survive in the long run. So many long-running industry veterans have been caught wrong footed ahead of the Swiss National Bank’s event.
While founders of retail foreign exchange brokers often have sales and marketing backgrounds, they do not have to be markets professionals. What they need is to have some market professionals on their teams, who can deliver a different view on the industry – one where the market is not just a place where retail traders are constantly wrong and not much bad can happen to a brokerage.
Understanding the Market and Hedging From Risks
Understanding global economics and risk management will only become more and more important in the current over-indebted global economic landscape. This industry is not insulated from risk events and it never has been, its just that everyone tends to forget things quickly on the financial markets before history repeats itself.
It would be great to see the industry start to think about the global factors that effect its businesses. With the central bank decisions widely affecting brokers’ businesses, volatility cycles and the environment across capital markets, recent events make the case that understanding the market is crucial to running a successful brokerage.
The industry has to understand that everything is possible on the financial markets and that rising volatility doesn’t only mean rising volumes. Once a central banker’s foot is off the gas pedal, some fundamental changes are due, which increase risks for the traders of any brokerage and for the company itself.
For the purposes of effective risk management, professional experience is a must. Any department which sticks to the old ways regardless of how it performed during this latest batch of black swan volatility is doomed to fail in the long run.
In its latest Quarterly Industry Report, Forex Magnates approached a couple of risk management professionals who shared their thoughts on risk management. Carl Elsammak from Kammas Trading and Jeff Wilkins from ThinkLiquidity shared their views on the challenges modern brokerages face.
To read the full report about the subject visit the Q4 Quarterly Industry Report page.