From our pixelated post bag, concerning that $100bn forex hustle:
I read your story with great interest. I traded equity indices and FX very actively at the end of last year/ early this year with one of the big UK cfd firms, and I would make 2 comments:
(i) you are absolutely right that the average punter doesn’t understand the interaction of volatility and leverage. I very rarely use stop-losses, preferring instead to take a directional view and make sure that I always have enough money in my account to cover any volatility – ie making sure that I can live with, say, a 10% move against me before the trade (hopefully) goes the way I want. However, although this is a sensible strategy, I have found that I have lost when either (a) I haven’t allowed for enough volatility – ie the market has moved 15% against me; (b) I’ve chickened out when in the red; or (c) I have got greedy, placed too big a bet, forgotten all caution and been burned. All that is to say that used sensibly, leverage is a good thing, but many people lose perspective, get too aggressive, and that’s when they lose.
(ii) MUCH more important, I am absolutely convinced that the firm with which I was trading used stops against me a number of times. I would place, say, a buy trade on the FTSE with a stop 50 or 100 points below and leave my screen. Sometimes only minutes later (particularly if I was trading outside main market hours), the stop loss would be triggered. Looking at the charts, I would find that the index would temporarily spike down to my stop level, close me out, and then go back to where it had been.
That is essentially riskless profit to the trader/ cfd firm. I am sure that what is happening is that the trader can see active orders but also all the stop orders lined up in his book. Whenever a stop order reaches the front of the queue (which can be quite often in an illiquid market) he simply fills that order, locks in a huge profit, and then goes back to making prices at the more normal level. I suspect that the same thing probably happens even in busier times, but it’s much harder to prove. I obviously have all my trade confirmations but haven’t yet gone through them all to make a ormal case, although I am 100% sure that I am right.
So far, I have been tempted to put it down to experience, and learn the lesson that stops are really there to protect positions that are too big/leveraged in the first place, and try to avoid stops at all costs. However, I do worry that actually this scam accounts for a very significant portion of the profits of these firms. Have you ever come across similar allegations from others? I think that this is a huge scandal waiting to break. All trading strategies disseminated by these firms advocate the use of stops; I would actually suggest that they are almost always bad for the punter – which I think is your point, too.
Rings true, eh?
Typically, the forex trading operations offering services (and reckless leverage) to retail punters have a relationship with a wholesale forex supplier – i.e. a big bank. The bank quotes commercial rates, derived from the professional global forex market. But playthedollarandwin.com, or whoever, control the rates they quote to their “customers” – otherwise known as “counterparties.”
With access to information on all customers’ positions, the temptation to shake the tree with a little home-grown volatility must be enormous.
Especially when the SEC, the FSA and all other financial regulators appear to be asleep at the wheel.
Related links:
Forex-marketing goes mainstream – FT Alphaville
Mrs Robo Jones starts to make an FX impact - FT Alphaville
Free money! Honest – FT Alphaville