The Retail FX Market Is a Complete and Utter Joke

I wrote a post almost 3 years ago in my “trading rules” series called “Understand the Product You Are Trading.”  A simple concept, indeed, but one which is most certainly often ignored by many, myself included.

In case you’ve been living under a rock for 4 days (or, in my case, been on a multi-day New York City bender), the Swiss National Bank abandoned the peg of their Swiss Franc to the Euro.   The results were explosive (chart courtesy of Katie Martin @ the Wall Street Journal):


The fallout was spectacular.   For those unaware: many retail foreign exchange (FX) trading shops offer clients massive leverage in order to entice them to trade.   As the head of one recently-imploded FX broker commented previously, ““Currencies don’t move that much… so if you had no leverage, nobody would trade.”   *gulp*.   The way this works is that you put up $1000, and you’re able to control $50,000 or $100,000 worth of notional.   The problem, of course, is when the entity you are trading moves more than your margin percentage – or, perhaps, moves *much* more than your margin percentage…   When your $100,000 position loses 25% in an instant, the math becomes problematic not just for you, but for the broker who controls your account and who loaned you the money for your margin position.

In my dollar denominated example (to keep things simple), if you have $2000 equity and 50-1 margin leverage (a $100,000 position), and you lose 25%, your position is now worth $75,000 and your equity is zero – negative to be more accurate.  You owe your broker $95,000 that you borrowed from him, but you have $75,000 worth of “stuff” in your account.  Uh oh.    There’s an old saying: “if you owe the bank $10,000, you have a problem.  If you owe the bank $1,000,000, your bank may have a problem.”  In this case, many retail FX brokers were in that latter situation:  they had negative capital after their clients imploded – using the brokers’ money – on long EURCHF positions (short the Swiss Franc).  Yadda yadda yadda – the retail FX brokers were in a world of hurt.

This is all background, however, for the point I’m trying to get to about the scariest reality of the FX market:  it appears that it’s all just a gigantic farce.  Your fills aren’t real – did you know about this “legal” quirk?   Let me explain.

I am generally not a global macro trader.  I am not an FX trader.  I have, however, in my Interactive Brokers account, occasionally dabbled in FX (USDJPY for example).   If you told me that the fills I’m getting when I trade aren’t fills at all, and that my broker can come back after the fact and adjust my prices – sometimes drastically – well, that would be news to me.   Is it my responsibility to understand that?  Well, as I wrote in the post linked above: of course:  we must know the rules of the products and markets we are trading.  But how many FX traders were aware that their fills aren’t really *real* fills but are more like “indicative* fills?

Here’s Katie Martin again:

“Tough love Friday from Saxo Bank A/S which, as we report here, has gone back to clients to say any Swiss franc trades it seemed to process on customers’ behalf during a half hour window on Thursday morning have been revised. Clients won’t get the rates they thought they hit on the screen after all. Awkward.”

Ok – so Saxo Bank has told clients that their fills were no good.   How the heck did that happen?  Martin continues:

“To understand how this came about, here’s a very crude rundown of how retail brokers work:

Big wholesale currencies-dealing banks pump out prices. Retail brokers suck those prices in, add a bigger spread, and push them out to mom-and-pop traders under their own name. So the brokers handle all the client interaction, and snag the extra spread, and the big banks get a bit of extra business without all the fiddly issues that come with handling relatively unsophisticated clients.

This works fine, until it doesn’t.”

If you’re an equities guy like me, you still don’t see the problem.   Even in volatile periods, this business model still works fine: liquidity suffers in times of increased volatility – obviously – but the brokers are still more than capable of transacting and marking up client fills with a small vig built in.  If they’re not capable of transacting, guess what – DON’T QUOTE THE UNDERLYING!   A nonsensical quote that will be reneged upon after the fact is much worse for a trader than a legitimate quote at the proper (even if inferior) price.

Back to Martin:

“Why doesn’t the market just take a break completely at times like this? Just like in equities? Well, it can’t.

There is no single venue for currencies trading. Banks have their own trading systems, and there are some aggregators that pull different banks’ prices together, but it’s really not possible to ‘stop’ trading altogether.”

I’m still not following.  If you’re my broker, and you can’t fill me at 1.15, don’t quote me 1.15.   This isn’t rocket science.  If the price at which you can fill me in EURCHF is .91, then quote me .91.   Why is this difficult?

In reality, what we’re doing is making excuse for brokers who either lack the technology to know where they can actually manage their risk, or who have a business model that doesn’t allow them to do so.   Why are we making excuses for them?

Martin conclude:

“Any brokers that were still pumping out prices to mom and pop while the Swiss was hitting the fan were unable to fill those trades at the prices that mom and pop thought they were getting. So the brokers have a choice: honor the rates the clients hit on the screen, and wear the loss, possibly toppling the entire company; or renegotiate the fill rates with clients to push some losses on them.”

Here’s my opinion: any brokers that were still pumping out prices to mom and pop that were unable to actually execute at those prices are complete and utter frauds.

NOW – we need to get back to my disclaimer:  I am not a regular FX trader, and the amazing/ludicrous/shocking part of this story is that it seems that this is *LEGAL* in the retail FX market!   These brokers are NOT complete and utter frauds – that’s just how this market works!   Which is why I’m writing this post.   I didn’t know that this product worked like this – even though I’ve traded it – and I’d be willing to bet that most of the traders in this market didn’t know that their fills aren’t real fills at all:  that their broker can just come back after the fact and restrike their fill at a level drastically different from the initial report due to the broker’s gross incompetence of quoting you a price at which they couldn’t really transact.

So now you know – and the next time you get burned on an absurd (legal!?) technicality of the retail FX market, it’s on you…

Just to wrap this up, I want to go back to another quote in Katie Martin’s article, from Saxo Bank CEO Steen Blaafaik:

“I think it was a fair way of dealing with it. Clients that lost money can blame us, or they can blame themselves. We have always helped and guided them on their risk management of the Swiss franc and warned of the risk.”

Again, I am not a Saxo Bank customer, and I did not lose money trading the Franc, but it seems like this is completely missing the point.   Clients aren’t blaming Saxo because the client was on the wrong side of a losing trade – clients are blaming Saxo because Saxo told them “yes, you’re done at 1.184” and then came back after the fact and said “oops- we meant .9625.”  That’s just friggin’ crazy – and if the response is “hey, that’s how the FX market works,” well then again, that’s what I want to scream loudly in this post just so everyone knows is:

That’s how the FX market works – Caveat Emptor


Trading Rule #3:  Know the Product You Are Trading

Katie Martin’s WSJ Post on Saxo


ps:  I’ve written a number of times about the problem with cancelling trades in the equities markets.   Does that mean that the equity markets are a complete and utter farce too?   When trades get cancelled they are, I guess – and as I’ve noted in my posts, there is no reason for these cancellations to happen: prevent them in the first place.   This is where FX is different: there’s no central exchange that can prevent these “bad trades” from happening in the first place.  However, FX also has less of an excuse, as the brokers are propagating prices which they cannot interact with, and creating the problems of erroneous fills themselves.


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