Earlier this week the Swiss National Bank (SNB) scrapped its
three-year-old cap on the franc against the euro. The announcement came as a
huge surprise to the currency markets and within minutes the Swiss franc jumped
30% against the euro and the US dollar. In the world of Forex currency trading,
where Billions are traded and retail traders can take advantage of high
leverage, a 30% move meant those with short positions on the Swiss franc had
their accounts wiped out in minutes. Liquidity completely disappeared. There
were no takers on the opposite side. Those with stop losses found that
brokerages had shut down trading. Stop losses mean nothing when trading is
stopped.
Retail traders were snuffed out. Understand that with a $10,000
account you could be controlling $200,000 in currency – that is leverage. When
there is a 30% move the other way against you in such a short time, it creates a $60,000
loss. The small $10,000 account is wiped out. Then the FX broker is scrambling
to shut down his position while there is no liquidity. Major FX trading houses
like Alpari (UK) failed… wiped out. FXCM in the US was chest deep in debt and
had to have money poured into them from outside. A large Everest capital hedge
fund has closed. The fund had been betting that the Swiss franc would decline. Many will ask, why were they not truly hedged... hedging costs money. In the chase for larger returns, we leave ourselves open to more risk. While shorting (selling) the Swiss franc against the USD or euro, one could buy calls out of the money and hedge one's position, reducing risk. Most don't.
Looking at the chart below on FXF we can see that the technicals were pointing
downward for the Swiss franc when the announcement came. However after the announcement by the SNB and FXF spiked. FXF is not a
leveraged instrument but FX currency trading is and so are futures.
Some people came out like bandits. Maybe rich Russians who had
moved money out of the ruble and stuck them in Swiss francs in Swiss banks… Swiss chocolates, Swiss vacations and Swiss
cheese are now a lot more expensive… all this makes me realize the risks in
leveraging. While returns can be quick and fast, a major black swan event will
wipe out accounts, brokerages and create massive losses for the major banks and
it did. I will always remember the ugly side of leveraging…and hope it never gets me...these are the dangers of trading FX and futures markets... risk and reward are inexorably tied together.. just different ends of the same spectrum.
