Retail Currency Brokers Earn 'Near-Certain' Returns Trading Against Their Own Clients

[brownsfan019 17]

Retail Currency Brokers Earn 'Near-Certain' Returns Trading Against Their Own Clients

 

The latest IPO prospectus for Gain Capital, a retail currency trading brokerage, reminds us again just how awfully disadvantaged retail currency traders are.

 

The word surely needs to get out more, since as it stands Gain Capital has grown its customer trading volume by an absurd 88% per year on average from 2004 - 2008.

 

FTAlphaville nicely highlights the most shocking aspect of the whole business - these companies are essentially trading against you as a counterparty.

 

They don't even appear too concerned about hedging currency exposure given that their business model offers 'near-certain' returns trading against their customers.

 

FTAlphaville: Here’s how it works. Our Madcap Speculator (MS), having been lured by an advert or other promotion, puts up $500 to “play the dollar.” He thinks the dollar is going to 1.75 versus the Euro — and he may well be right, given that we’ve already moved from 1.25 to 1.50 in the past six months or so.

 

FXhustle.com offers the Madcap Speculator 200x leverage on his initial margin deposit of $500. That allows the client to go long the euro and short the dollar to the tune of $100,000.

 

Now, either because he’s cautious or because FXhustle have insisted he do so, our MS places a stop loss on his trade — limiting his total possible losses to $1,000.

 

Which is where FXhustle becomes the near-certain winner and Madcap Speculator becomes the likely loser.

 

MS might be right about dollar/euro going to $1.75, but even if it does, we can be absolutely certain that it will NOT do so in a straight line. And, because he’s levered 200 times, our little speculator cannot sustain much volatility without being stopped out.

 

FXhustle, on the other hand, acting as MS’s counterparty, can endure much greater price divergence — even without having a view on the future of the dollar.

 

In its role as counterparty, the firm is taking bets from tens of thousands of customers across dozens of currency pairs. It can maintain a neutral market position while banking the spread between wholesale FX rates and the quotes it offers the Speculators of this world. But it then sweeps up as soon as a client hits a stop loss — which the volatility in FX markets, together with excess leverage, makes a certainty.

 

With a simple algorithm covering market volatility and the leveraged state of clients, FXhustle can make near-certain returns — in just the same way that a casino takes a pre-defined cut at the roulette wheel.

[brownsfan019 17]

The $100bn FX hustle

 

The $100bn FX hustle

Posted by Paul Murphy on Nov 02 19:11.

 

$100bn — that’s the daily figure for trading volume in the retail foreign exchange market, where amateur plungers play the dollar and the like.

 

The IPO prospectus for Gain Capital, one of the scores of firms tapping into this area of explosive growth, sets out the juicy business on offer (emphasis FT Alphaville’s):

Foreign exchange, or forex, trading is one of the fastest growing areas of retail trading in the financial services industry. According to its most recent report, the Aite Group, a financial services industry market research firm, reported that by the end of 2008, average daily trading volume in the retail forex market reached approximately $100.0 billion, a 900% increase from 2001. Our total annual customer trading volume, which is based on the U.S. Dollar equivalent of notional amounts traded, grew from $120.3 billion in 2004 to $1.49 trillion in 2008, representing a compounded annual growth rate of 87.6%. Our annual customer trading volume from customers residing outside of China grew from $114.3 billion in 2004 to $1.32 trillion in 2008, representing a compounded annual growth rate of 84.3%.

 

Compound annual growth of almost 88 per cent? ALARM BELLS PLEASE!

 

We should state at the outset here that to our knowledge Gain Capital, better known as FOREX.com, are neither better nor worse than any other retail FX trading service provider.

 

But my, isn’t Gain profitable: net income has multiplied from $7.1m in 2004 to $231m in 2008, representing compound annual growth of 138 per cent.

 

But at whose cost? Step forward would-be FX speculators drawn from retail clients the world over.

 

The FOREX.com website, like the firm’s IPO prospectus, contains lots of warm words about enabling ordinary people to gain access to markets that were once the preserve of the professionals. There’s a stress on things like “education”,”managing risk in real time,” and other such intangibles.

 

The site also warns — in small print at the bottom of the page — that “forex trading involves significant risk of loss and is not suitable for all investors” and that “increasing leverage increases risk”. There’s also a separate page warning of the risks inherent to forex trading and the additional dangers of using an Internet-based platform.

 

Go to any of these sites — FXCM.com, Global Futures & Forex, Oanda.com, etc — and you will get the distinct impression that you are dealing with a warm-hearted, professional broker, where your interests are paramount.

 

But in many cases the exact opposite is the case. Note this line from the Gain prospectus:

 

The majority of our revenue is derived from our activities as a market-maker to our retail customers, where we act as the counterparty to our customers’ trades.

 

We would also highlight, in abstract, these two statements from the ‘risk factors’ section of the IPO doc:

 

Our customer base is primarily comprised of individual retail customers who generally trade in the forex market with us for short periods…

 

…If we are unable to maintain or increase our customer retention rates or generate a substantial number of new customers in a cost-effective manner, our business, financial condition and results of operations and cash flows would likely be adversely affected. For the year ended December 31, 2008, we incurred sales and marketing expenses of $29.3 million.

 

And then deeper into the prospectus:

 

As a market-maker, we take an equal and opposite position to our customers when executing a trade. We believe it is neither economically optimal nor necessary from a risk perspective to hedge all of our customers’ trades on a one-to-one basis…

 

…Trading revenue is our largest source of revenue and is derived from gains, offset by losses, from our trading positions and our revenue resulting from dealing spreads on customer transactions where we earn the difference between the retail price quoted to our customers and the wholesale price received from our wholesale forex trading partners…

 

…We offer both standard and mini accounts, which allow customers 100-to-1 and 200-to-1 margin…

 

We could go on. The 150 page FOREX.com prospectus provides dozens of talking points.

 

But let’s concentrate on the core issue here: how do those operating retail FX punting services make so much money?

 

——

 

Here’s how it works.

 

Our Madcap Speculator (MS), having been lured by an advert or other promotion, puts up $500 to “play the dollar.” He thinks the dollar is going to 1.75 versus the Euro — and he may well be right, given that we’ve already moved from 1.25 to 1.50 in the past six months or so.

 

FXhustle.com offers the Madcap Speculator 200x leverage on his initial margin deposit of $500. That allows the client to go long the euro and short the dollar to the tune of $100,000.

 

Now, either because he’s cautious or because FXhustle have insisted he do so, our MS places a stop loss on his trade — limiting his total possible losses to $1,000.

 

Which is where FXhustle becomes the near-certain winner and Madcap Speculator becomes the likely loser.

 

MS might be right about dollar/euro going to $1.75, but even if it does, we can be absolutely certain that it will NOT do so in a straight line. And, because he’s levered 200 times, our little speculator cannot sustain much volatility without being stopped out.

 

FXhustle, on the other hand, acting as MS’s counterparty, can endure much greater price divergence — even without having a view on the future of the dollar.

 

In its role as counterparty, the firm is taking bets from tens of thousands of customers across dozens of currency pairs. It can maintain a neutral market position while banking the spread between wholesale FX rates and the quotes it offers the Speculators of this world. But it then sweeps up as soon as a client hits a stop loss — which the volatility in FX markets, together with excess leverage, makes a certainty.

 

With a simple algorithm covering market volatility and the leveraged state of clients, FXhustle can make near-certain returns — in just the same way that a casino takes a pre-defined cut at the roulette wheel.

 

The only trouble for FXhustle is that it needs to keep finding new Madcap Speculators willing to lose their money in this way.

 

——

 

Returning to our real life example in the form of Gain Capital and FOREX.com, we can see that the firm currently has around 33,000 active customers collectively betting a nominal $1,200bn annually. For every $1m wagered by its clients, FOREX.com generated revenue of $122.

 

The firm does not appear to have divulged a figure for client churn, so it is difficult to know how many customers might be getting burnt on a monthly basis. What we do know is that advertising and promotion spending is running at $30m a year at Gain Capital, ranking second only to staff costs.

 

FOREX.com, like others in the same business, is regulated to the n-th degree — both from a capital adequacy perspective and from the advertising/promotion/consumer protection side.

 

But do the National Futures Association in the US and the FSA in the UK actually understand the hardwired hustle going on here?

 

If not, it’s about time they did.

[brownsfan019 17]

I read articles like that and it just reinforces why I don't head into the FX shark infested waters.

[littlefish 10]

As far as the hedging goes, what would stop a futures broker from playing the same game?

 

If they execute trades for you, they can execute their own trades along side you.

 

I would assume that even though the sharks exist in the waters. There are certain maneuvers that they physically cannot do. Or even if they have dominion over most of the ocean, surely they can't devour it all.

[brownsfan019 17]

  littlefish said:

As far as the hedging goes, what would stop a futures broker from playing the same game?

 

If they execute trades for you, they can execute their own trades along side you.

 

I would assume that even though the sharks exist in the waters. There are certain maneuvers that they physically cannot do. Or even if they have dominion over most of the ocean, surely they can't devour it all.

 

B/c the quotes are centralized. When I trade futures, Open ECry doesn't get to dictate where prices go and what prices to report. They must report what the CME reports. They can trade against me, but the ultimate prices being reported are not dictated by them; whereas in FX it's like playing poker against an opponent that knows your hand.

 

If your opponent knows where you will give up on the trade, think they could use that to their advantage?

[littlefish 10]

  brownsfan019 said:

If your opponent knows where you will give up on the trade, think they could use that to their advantage?

 

Sure if they have power enough to move the entire market past extremes.

 

It would seem that there would have to exist some walls in which a wrecking ball can't even penetrate. Until it at least takes a few swings at it.

 

I'm not into poker, but yet and still. Is it not valuable in some instances to make your opponent think that you have more power than you actually do?

 

If so then couldn't that lead your opponent on a mystical mental wild goose chase after a goose that never existed in the first place?

[brownsfan019 17]

How about when your opponent also controls price swings b/c they make the quotes? That's what you are missing here -- futures are centralized, fx is up to each broker to report their numbers.

 

Anyways, a couple good articles and it shows another story of the fx world which simply doesn't exist in futures.

[clockwork71 10]

I have been a profitable FX trader for a few years, and also trade other markets. To be honest, I haven't felt any difference. I think it really comes down to who you are using, and trade size. If you are a large enough trader, you aren't messing with these little bucketshops anyways. I trade FX through an ECN now, so it's not even an issue.

 

But back in the old days, I traded at GFT, Interbank FX, and Gain. I never had an issue. The main reason in my opinion: I wasn't taking as nearly as much as the rest of the clinents were giving.

 

Sorry about the Browns. They are an embarrassment for the entire state. :haha:

 

Chris from Columbus

[zdo 20]

fx houses do not “control price swings b/c they make the quotes”. Yes they do all the things reported in the article above plus a few other deviant little tricks the articles didn’t cover but ---

If they widen or slip the spread outside the ‘tolerance’, they lose transactions immediately and the accts may punish them for months and months or even never come back.

Same for overall transaction costs.

If they deviate from other quotes (especially from ECN’s), there are algo’s just waiting to tear them a big new one…

Stops that are ‘close by’ get run on all the exchanges – as much (and even more sometimes) in futures than in fx.

Basically, all trading profits are made in spite of the house. It is the individual trader’s responsibility to optimize trxs costs period.

 

Yes, ‘they’ do increment millions and millions in teenytiny amounts at a time off retail accounts. However, operating with far less revenue than fx, another ‘they’ probably makes close to the same "near certain" absolute millions and millions in ‘dealing’ listed stocks by ‘taking’ larger (but still tiny) amounts from their 'clients'...

 

I just can’t support the notion that fx is significantly ‘crookeder’ than banks or exchange traded instruments. They are ALL crooked as hell… For example, currently Comex makes fx houses look like angels … they do not actually have in the warehouse the metals they are reporting they have… fishy serial numbers on bars… huge delays on delivery… exorbitant fees for delivery… The same kinds of sullied conditions can easily develop ‘overnight’ in energy, agriculturals, softs, etc.

 

Not saying trust fx houses at all! Am saying they are no less trustworthy than any of the other types of houses in the current system.

Not saying you’re overreacting to fx. Am saying you are probably under reacting to your other trading ‘exchanges’.

In truly turbulent times, you would have just as much luck closing your positions at reasonable prices and ordering a check in the amount of your balance from an fx house as you would any of the other “more carefully regulated” houses…

[DugDug 10]

and another thing....

those stinking banks, who take our deposits at 0.0001% and lend us money at 5%.

what about those insurance companies that insure our houses and make money out of it!

I cant stand the corner store that charges me 70 c for a chocolate bar when i know i can get it from the supermarket for 50c.

 

I think the point that someone is using 500 times leverage means that unless they really know what they are doing, very good, or just out and out plain lucky they will loose their money.

A market makers job is to provide liquidity, for that they expect to make money.

customers are free to choose where to go.

(by the way I occasionally use them and have no problems with them, but am not associated with them)

[DugDug 10]

just in over the bloomberg website....Goldman Sachs report.

 

The firm lost $3.6 billion in currency trading, more than double the $1.4 billion lost from that division in the second quarter.