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Issue: January, 2004
Gun-Slinging Forex Traders: Meet Up at
Online Venues: Retail Players Taking Larger Piece of FX Pie
by: Rob Luke
The latest new frontier in Internet trading is
pulling in the pioneers from all over. They might want to consider packing
the online version of a six-gun.
The recent surge in interest (and
some notoriety) in foreign exchange spot, futures and options markets, or
forex, shows many of the same characteristics of new frontiers past. Until
1972, when Nobel Laureate Milton Friedman teamed up with the Chicago
Mercantile Exchange and lent his imprimatur on the “opening” of regulated
foreign currency markets to the public via FX futures, mortal man had no
opportunity to partake of potential gains in these markets. Currencies
became the first financial futures market in history, one which, although
allowing the public to participate, has been mainly dominated by
international banks and corporations with a big stake in unforeseen,
adverse currency movements.
Today, like rapid growth fueled by a
rush of hopeful newcomers, exaggerated claims of new riches and businesses
are popping up (and down) overnight. Not to mention the hustlers,
fraudsters and straight-out raiders lurking in every saloon. But, this new
frontier also is doing what all new frontiers should: broadening the
overall horizons and opening up resources to all. This market now can be
traded over the Internet 24 hours a day, mostly with no commission and at
bid/ask spreads similar to the interbank market.
“(Unregulated)
currency markets have a fast and loose reputation,” said Anthony Frisone,
owner of Windsor Forex Trading Corp. in Coral Springs, Fla. Nonetheless,
he points out: “As the world shrinks, currency markets expand.” And, the
retail forex-trading market in America has certainly been expanding
lately. Traders have noted an increasing number of online currency trading
platforms (sometimes called ECNs, for electronic communications network)
on the Internet in recent months. By some estimates, according to Frisone,
of the approximately $1.5 trillion in forex traded per day, $30-$40
billion of it is retail money compared to almost no retail five years ago.
“The market is growing by leaps and bounds,” he says.
So, for some
forex trading platforms, business is growing at frontier-boomtown rates.
Michael Weiner, COO of Plainview, NY-based COESfx, says his service has
been growing steadily at a rate of about 20 percent per month. And, Josh
Levy, president of Manhattan-based CMC Forex, says his company, which
opened the world’s first online currency trading service in 1996,
increased its customer base 55 percent in three months after opening its
first U.S.-based operation. A significant number of those customers, he
said, have been trading futures and options, but were looking to expand
into other vehicles. “It’s a natural progression for (an equity) futures
trader, once they’ve learned the nomenclature, to move to currency
trading,” says Levy.
Fair Trading?
The dash to this new
frontier is understandable on several fronts. Most forex sites charge no
commission to enter or exit a position and no extra fees to take a short
position, although some charge transaction fees. Rather, most make money
on bid/ask spreads, which can be up to 10 points in some cases, or by
utilizing professional traders to take counterparty positions to their
customers. In addition, because the market is so liquid, they can ensure
that, for example, stops are filled at prices close to where they were
elected, according to Don Wilcox, president of New York City-based Helia
Asset Management. Wilcox, a 15-year veteran of forex trading and long-time
online service user, said low costs and some excellent Internet-based
trading services were tempting traders to switch to currencies. “They
don’t charge commissions, and they provide you with charting – it’s a very
fair playing field. When I get on a platform nowadays, it’s just as good
as anything I had during my interbank days.”
Wilcox praises his
preferred platform, CMC Forex, largely because “I understood their stops
policy.” But, he also points out that CMC Forex can maintain a tighter
bid/ask spread (a key consideration in a market with hardly any
commissions or fees) by making itself the counterparty to all
transactions. “Their time horizons are different, and they have enough
experience to handle themselves in the market,” Wilcox contends. Most of
their customers are essentially currency day-traders, whereas their own
traders can take short-term losses for long-term gains.
CMC Forex’s
Levy calls this business model the direct market-maker model. Using the
model, he said, “We disintermediated the broker who just tacks on the
brokerage.”
Frisone, a self-described “pick-up-the-phone guy,” only
began trading currencies online in January 2003 when invited to do so by
COESfx, which he now uses. What impresses him the most about the service
is that the bid/ask spreads it shows (one-two points) are the same as
those shown on the interbank markets’ EBS ticker (the system that matches
up all forex orders on the interbank market and broadcasts a bid/ask
spread for all currencies to participants). With a transaction charge of
$5 per $100,000, Frisone says he is saving 60 percent a year compared to
the major online forex brokers.
The way COESfx keeps spreads low is
that all forex trades are matched up on both sides with no human
intervention, according to Weiner. He claims that also makes COESfx “the
only true ECN out there offering the true ECN model.” COESfx matches
retail investors with major banks and other institutions by aggregating
smaller retail bids or asks to match up with the larger counterparty. As a
result “the bank’s price goes straight through to the
end-user.”
SIDEBAR
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Know
Your Online Venue
The black hats appear to be multiplying out
in the Wild West of forex trading. But the sheriffs are fighting back with
a bigger arsenal – and more to come.
The National Futures
Association (NFA), which oversees forex-dealer members, recently began
enforcing a new set of rules imposed on the NFA’s forex-dealer members.
The new rules (see insert box) were approved by the Commodity Futures
Trading Commission (CFTC), which regulates the off-exchange retail
forex-trading industry, in August.
The announcement of the new
rules coincides with what the CFTC acknowledges is an increase in the
number of fraud charges brought by the CFTC against forex dealers.
According to the CFTC website, of the 88 cases it prosecuted in the first
nine months of 2003, 25 were against companies charged in forex-related
activities.
Prior to the new rules, the CFTC and the NFA had taken
other steps to protect investors from cowboys in the forex-trading market.
In 2001, it launched a Forex Consumer Advisory and, in April 2002, an
advisory on how firms can legally deal in retail forex. A few months
later, the NFA created a separate membership category for CFTC-registered
firms offering off-exchange retail forex products to the public.
To
be fair, most if not all of the 25 CFTC cases were a matter of
misrepresentation or downright theft from relatively uninformed members of
the public. In most cases, the CFTC’s alarm bells ring when they hear
about or see a forex dealer’s marketing offering as high-return, low-risk
forex investments, said Hayeck of the CFTC.
The NFA concerns itself
more with ensuring that members meet minimum capital requirements and that
their books are kept in order. Between creating the forex-membership
category in June 2002 and announcing the new rules in August 2003, the NFA
took emergency enforcement actions against just three members.
In
this context, one of the new rules should give the sheriff an extra bullet
in the chamber. It raises the minimum capital requirement for a member
from the previous $250,000 to one percent of the total value of customer
and non-customer open positions.
Then there’s the rule forcing the
members (who are almost all futures commission merchants – FCMs ) to
supervise and take responsibility for the actions of employees, agents and
affiliates. As Sharon Pendleton, associate director of compliance for the
NFA, pointed out: “Before, (the rule) said you had to be an FCM to trade
forex but (said) nothing about entities who introduced the customers to
them, meaning they were unregulated.”
Closing this loophole looks
like being very popular amongst long-suffering traders. Frisone hailed the
rule as an attempt to force FCMs to guarantee any trades done through
their agents. His immediate response: “Happy day!”
And sheriff NFA
will assume more powers soon as the retail forex market continues to heat
up. Pendleton said the NFA intends to introduce more rules in the near
future. “We have a list of where we want to expand, but we’ll wait a while
and see how (the new rules) go.”
Too bad Gary Cooper’s not around
anymore.
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SIDEBAR
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New
rules from NFA on its forex dealer members as of December 1,
2003
Members are required to:
a) Observe high standards
of commercial honor and just and equitable principles of trade in
connection with the retail forex business;
b) Supervise their
employees and agents and any affiliates that act as counter parties to
retail forex transactions;
c) Maintain a minimum net capital
requirement based on the value of open customer positions; and
d)
Collect security deposits from those
customers.
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Wanted
Posters
Today’s retail forex trading scene may occasionally
resemble Dodge City, but old hands like Wilcox and Frisone have been
dodging bullets for years.
Foreign currency markets began
initially when exporters and importers wanted to hedge against currency
shifts, and were traded strictly on the interbank markets. Unregulated
retail forex trading began in the early 1990s when clearing houses opened
up to leverage smaller amounts, says Frisone, and soon accounts were being
blown out.
The mayhem more or less ended with the passage of the
Commodity Futures Modernization Act (CFMA) in 2000. The CFTC was granted
power to “close down entities selling illegal off-exchange foreign
currency futures and options contracts to retail customers.” But, as the
market grew again following the popping of the dot-com bubble and the
subsequent bear market in equities, so did the dirty pool and underhand
dealing. [See sidebar.]
Most of the CFTC’s cases involve
unsophisticated investors. But, Paul Hayeck, associate director of the
CFTC’s division of enforcement, says experienced traders get taken in as
well. One common way is for forex sites to advertise that they trade on
the interbank market, to which only the world’s largest financial
institutions have access. Instead, he says, “Your money ends up on their
trading desk up against one of their professional traders.”
Weiner
knows all about that problem. He and his partner started COESfx after
trading currencies on several other platforms and always ending up on the
other side of a professional trader. “It was like Vegas, and we were
playing the game with the worst odds,” he recalls.
Frisone keeps
the hammer on his six-shooter cocked for a different kind of black hat
online: those with inflated bid/ask spreads. He compares the spreads he’s
getting with COESfx with the interbank market (both around 1.5 points) to
those offered by most online forex brokerages of between three-ten points.
“Some are showing 40-50 when it’s 45-46 on the interbank – at that
price it’s a lovely casino for them,” he says. “These guys don’t realize
that the spread is tightening, and soon (exchanges like) COES will steal
their business. Wilcox, by contrast, has been trading forex online for a
number of years and has used a number of different online trading
platforms. He says the difference between them is in the integrity with
which the service deals with its customers and, therefore, believes that
both models – match-up and brokerage – can co-exist.
Frontier
Land
Despite the dangers, though, the forex frontier looks sure to
lure more adventurers in search of another trading vehicle in which to
diversify. Trading price and Internet access aside, trading foreign
currency options and futures offers a number of advantages over other
markets. The one most-often mentioned is the fact that the market, from
its opening on Sunday afternoon in Wellington, New Zealand, to its close
on late Friday afternoon, is 24 hours. That means that traders can decide
which hours they want to trade, depending on what suits their sleep/wake
patterns best. It also means traders can virtually always escape a bad
trade.
This non-stop access is generally good but can have a
downside, according to experienced traders. Frisone likes the freedom it
gives him to check events in the middle of the night for trading
opportunities. He then can take naps during periods of slow activity, such
as late afternoon in New York. Wilcox generally agrees that the 24-hour
routine provides extra trading opportunities and escape routes, noting
that he generally goes to bed at 2:00-3:00 a.m. but wakes up during the
night to sneak peeks at the market. “Your trading room becomes your
bedroom, so to speak,” he said. “That can be a problem.”
The
“bigger picture” reason for bullishness on forex is the growing
interaction between countries’ economies and, thus, the expansion of trade
and currency movements between them. This expansion is expected to propel
further liquidity in the foreign currency markets, already the most liquid
in the world, and lead to greater “retailization” of the
market.
Banks Starting to Take Notice of Retail
Guys
Traditionally there have been three tiers of the forex market:
interbank (EBS), institutional and retail platform. But, as the retail end
of the market has continued to expand, top-tier banks are now taking a
serious look at the retail market, according to Wilcox. “The interbank
market can remain an exclusive club but can open a kind of country club to
tap institutional and retail investors,” he contends.
At the
mainstream level, forex growth can be noted on active traders’ favorite
channel, CNBC, according to Weiner of COESfx. “Every 15 minutes they have
an update on the euro, yen and dollar. It is the kind of thing that gets
the general public interested in trading.”
Go West?
For
futures and options traders inexorably drawn to the promise of a brave new
frontier, old hands have some good news. Experienced traders in other
markets can do well in forex, but need to do plenty of homework. Although
the forex market lends itself well to technical analysis, traders need to
become familiar with a wider range of economic data from different
economies, rather than just quarterly announcements from local companies.
Then they need to distinguish between currency pairings that are risky to
trade and those that are relatively safe.
For example, Frisone
warns neophyte forex traders to stay clear of the U.S. dollar/Japanese yen
pairing, despite its high profile. “A lot of technical analysis (on
dollar-yen) goes out the window because of the import-export factor,” he
says. “Big-company hedging will shift it.” A safer bet, he says, is the
dollar/euro pairing, which accounts for 90 percent of forex trading
activity.”
Frisone also cautions traders to stay clear of high
leverage in the currencies markets. “It’s all about leverage – if it’s too
high you can lose five to ten percent in one day,” He says the “absolute
maximum” level of leverage in this market should be 5:1.
But
traders say the real advantage to playing the forex market is the
potential returns offered by smaller-market currencies. Wilcox pointed to
this year’s run-up of the Brazilian real and the Australian dollar as good
examples.
Nonetheless, Frisone strongly advises against traders
jumping into the market too quickly. “I’ve seen so many stocks and
commodities guys get hammered in currency,” he said. “This is where people
like me come in - we let you get involved with a professional first and
then dabble on your own.”
Riding shotgun, as it were.
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