The idea of margin (leverage) and floating loss is another important trading concept and is perhaps best understood using an example. Most retail Forex market makers permit 100:1 leverage, but also, crucially, require you to have a certain amount of money in your account to protect against a critical loss point. For example, if a $100,000 position is held in Eur/USD on 100:1 leverage, the trader has to put up $1,000 to control the position. However, in the event of a declining value of your positions, Forex market makers, mindful of the fast nature of Forex price swings and the amplifying effect of leverage, typically do not allow their traders to go negative and make up the difference at a later date. In order to make sure the trader does not lose more money than is held in the account, Forex market makers typically employ automatic systems to close out positions when clients run out of margin (the amount of money in their account not tied to a position). If the trader has $2,000 in his account, and he is buying a $100,000 lot of EUR/USD, he has $1,000 of his $2,000 tied up in margin, with $1,000 left to allow his position to fluctuate downward without being closed out. Typically a trader's trading platform will show him three important numbers associated with his account: his balance, his equity, and his margin remaining. If trader X has two positions: $100,000 long (buy) in EUR/USD, and $100,000 short (sell) in GBP/USD, and he has $10,000 in his account, his positions would look as follows: Because of the 100:1 leverage, it took him $1,000 to control each position. This means that he has used up $2,000 in his margin, out of a $10,000 account, and thus he has $8,000 of margin still available. With this margin, he can either take more positions or keep the margin relatively high to allow his current positions to be maintained in the event of downturns. If the client chooses to open a new position of $100,000, this will again take another $1,000 of his margin, leaving $7,000. He will have used up $3,000 in margin among the three positions. The other way margin will decrease is if the positions he currently has open lose money. If his 3 positions of $100,000 decrease by $5,000 in value (not at all an unusual swing), he now has, of his original $7,000 in margin, only $2,000 left. As discussed above, if you have a $10,000 account and only open one $100,000 position, this has committed only $1,000 of your money plus you must maintain $1,000 in margin. While this leaves $9,000 free in your account, it is possible to lose almost all of it if the position dives. On the other hand, if you have 5 positions open in a $10,000 account, you can lose only $5,000 because the other $5,000 is held in margin. However, this does not make it safer to hold more positions. The Forex market fluctuates so rapidly, that with shallow margins, you are much more likely to be closed out of your position and lose it entirely when it might have recovered from a temporary fluctuation if you had had sufficient margin to cover the variation. The more positions open at one time, the more risk the trader is exposed to. Transaction costs and market makersMarket makers are well compensated for allowing retail clients to enter the Forex market. They take part or all of the spread in all currency pairs traded. In a common example, EUR/USD, the spread is typically 3 pips (3/100 of a percent). Thus prices are quoted with both a Buy and Sell price (e.g., Buy Eur/USD 1.2000, Sell Eur/USD 1.2003). That difference of 3 pips is the spread and can amount to a significant amount of money. (Note: the spread is only taken out at the beginning of the trade; this transaction cost is subtracted only upon entering the trade, not leaving it) Because the typical standard lot is 100,000 units of the base currency, those 3 pips on EUR/USD translate to $30 paid by the client to the market maker. However, a pip is not always $10. A pip is 1/100th of a percent, and the currency pairs are always purchased by buying 100,000 of the base currency, which is also known as the counter currency. For the pair EUR/USD, the base currency is USD; thus, 1/100th of a percent on a pair with USD as the base currency will always have a pip of $10. If, on the other hand, your currency has Swiss Frank (CHF) as a base instead of USD, then 1/100th of a percent is now worth around $8, because you are buying 100,000 worth of Swiss Franks. If a trader with a $10,000 account on 100:1 leverage felt, after reading reports on the economy, that the USD was going to go up in value against the EUR and the CHF, he would Sell EUR/USD (thus selling EUR and buying USD) and Buy USD/CHF (buying USD and selling CHF). The transaction is all electronic, so the trader doesn’t need to have Euros in his account. On a large scale, the market maker can sell Euros on behalf of the trader, knowing that the position will eventually be closed and converted back to USD. Assume that the client sold 100,000 EUR/USD at 1.2000 and bought 100,000 USD/CHF at 1.2500. Seconds after this transaction, his account would read: Balance: $10,000, Equity $9,946. The loss of $54 is due to the transaction cost taken only at the entry of a position of 3 pips, which translates to $30 for the EUR/USD pair and $24 for the USD/CHF pair. With equity of $9,946 on 100:1 leverage with 2 positions opened, $2,000 is now held in margin, leaving the trader $7,946 in usable margin. Suppose the EUR/USD (sold at 1.2003) starts to move against the trader and goes up in value to 1.2013, while the USD/CHF (bought at 1.2500) starts moving for the client and also goes up in value to 1.2515. His account information will have changed but his balance and margin will remain unchanged at $10,000 and $2,000 respectively. His equity and his usable margin, however, will change to reflect the new market conditions. While for the trader, the platform will calculate this all automatically, it is important to see it step by step. Beginning Summary Step 1: Client XXX places two trades. Balance remains: $10,000 Step 2: Market Conditions Change, with EUR/USD going up 10 pips (a 10 pip decrease in value to the client, since he is short EUR/USD), while the USD/CHF has increased in value by 15 pips. EUR/USD pair has lost 10 pips, with each pip $10 so it has lost $100 Balance: $10,000 Step 3: Client closes both positions (by performing the opposite trade – Buying EUR/USD and Selling USD/CHF). He now has no positions in the market, and his money is no longer fluctuating with the market. Balance: $9,966 Financial InstrumentsThere are several types of financial instruments commonly used. Forwards: One way to deal with the Forex risk is to engage in a forward transaction. In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be a few days, months or years. Futures: Foreign currency futures are forward transactions with standard contract sizes and maturity dates — for example, 500,000 British pounds for next November at an agreed rate. Futures are standardized and are usually traded on an exchange created for this purpose. The average contract length is roughly 3 months. Futures contracts are usually inclusive of any interest amounts. Swaps: The most common type of forward transaction is the currency swap. In a swap, two parties exchange currencies for a certain length of time and agree to reverse the transaction at a later date. These are not contracts and are not traded through an exchange. Spot: A spot transaction is a two-day delivery transaction, as opposed to the Futures contracts, which are usually three months. This trade represents a “direct exchange” between two currencies, has the shortest time frame, involves cash rather than a contract; and interest is not included in the agreed-upon transaction. The data for this study come from the Spot market The Difference between Spot and Futures in ForexBefore a de******ion of retail trading, it is important to understand the difference between the Spot and Futures markets. Futures are generally based on contracts, with typical durations of 3 months. Spot, on the other hand, is a two-day cash delivery. While the Futures markets was created to hedge out risks and speculate on future market conditions, Spot was created to allow actual cash deliveries. Spot developed a two-day delivery date in order to give those transporting the actual cash a window of time to receive it. While in theory there still is a two-day delivery date imposed after a Forex transaction, this is effectively no longer used. Every day, at 5 pm EST (the predetermined end of the trading day) Spot positions are closed and then reopened. This is done in order to guarantee an unlimited timeline for delivery. For example, if a Spot transaction occurs on a Monday, the delivery date is Wednesday. At 5 pm on Monday, the position is closed and then immediately re-opened; now this is a new position with the close date of Thursday. This daily process allows an investor to hold open a position indefinitely. Another important difference between Futures and Spot is how interest is credited. Each currency in a Forex transaction has an inherent interest rate attached to it. In the case of the US dollar, this is the Federal Funds Rate. This interest is added every single day whether the market is trading or not. Interest cannot take a vacation; money and its loaning value are still important even if the financial world has stopped dealing. In Futures, the interest is built into the price of the contract. In Spot, however, interest is not taken into account in the offering price because the Spot market is a cash market, not a contract market. There must be some mechanism for crediting interest, and various institutions have developed ways to do it. The most common method is to credit that day’s worth of interest at the same time they “flip” the position, or carry it over to the next day. This is important for later discussions and analysis because the transactions examined in this study had interest credited at the end of the business day at exactly 5 pm EST. If a position was held from 5:01 pm on Tuesday and closed at 4:59 pm on Wednesday, no interest would be credited for that day. If, on the other hand, a position was opened Tuesday at 4:59 pm and closed Tuesday 5:01 pm, a full day’s interest would be credited. This has interesting ramifications; traders who work intra-day, or “day traders,” often do not use interest for either gain or loss. |
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• 4/8/2007 - CFTC warnings
CFTC warningsThe CFTC lists 9 warning signs for foreign exchange trading fraud: 1. Stay away from opportunities that seem too good to be true Always remember that there is no such thing as a "free lunch." Be especially cautious if you have acquired a large sum of cash recently and are looking for a safe investment vehicle. In particular, retirees with access to their retirement funds may be attractive targets for fraudulent operators. Getting your money back once it is gone can be difficult or impossible. 2. Avoid any company that predicts or guarantees large profits Be extremely wary of companies that guarantee profits, or that tout extremely high performance. In many cases, those claims are false. The following are examples of statements that either are or most likely are fraudulent "Whether the market moves up or down, in the currency market you will make a profit.""Make $1000 per week, every week""We are out-performing domestic investments.""The main advantage of the forex markets is that there is no bear market." "We guarantee you will make at least a 30-40% rate of return within two months." 3. Stay Away From Companies That Promise Little or No Financial Risk Be suspicious of companies that downplay risks or state that written risk disclosure statements are routine formalities imposed by the government. The currency futures and options markets are volatile and contain substantial risks for unsophisticated customers. The currency futures and options markets are not the place to put any funds that you cannot afford to lose. For example, retirement funds should not be used for currency trading. g. You can lose most or all of those funds very quickly trading foreign currency futures or options contracts. Therefore, beware of companies that make the following types of statements: "With a $10,000 deposit, the maximum you can lose is $200 to $250 per day. "We promise to recover any losses you have." "Your investment is secure." 4. Don't Trade on Margin Unless You Understand What It Means Margin trading can make you responsible for losses that greatly exceed the dollar amount you deposited. Many currency traders ask customers to give them money, which they sometimes refer to as "margin," often sums in the range of $1,000 to $5,000. However, those amounts, which are relatively small in the currency markets, actually control far larger dollar amounts of trading, a fact that often is poorly explained to customers. Don't trade on margin unless you fully understand what you are doing and are prepared to accept losses that exceed the margin amounts you paid. 5. Question Firms That Claim To Trade in the "Interbank Market" Be wary of firms that claim that you can or should trade in the "interbank market," or that they will do so on your behalf. Unregulated, fraudulent currency trading firms often tell retail customers that their funds are traded in the "interbank market," where good prices can be obtained. Firms that trade currencies in the interbank market, however, are most likely to be banks, investment banks and large corporations, since the term "interbank market" refers simply to a loose network of currency transactions negotiated between financial institutions and other large companies. 6. Be Wary of Sending or Transferring Cash on the Internet, By Mail or Otherwise Be especially alert to the dangers of trading on-line; it is very easy to transfer funds on-line, but often can be impossible to get a refund. It costs an Internet advertiser just pennies per day to reach a potential audience of millions of persons, and phony currency trading firms have seized upon the Internet as an inexpensive and effective way of reaching a large pool of potential customers. Companies offering currency trading on-line will usually be located in different legal jurisdictions to you. Even if they display an address or any other information identifying their nationality on their Web site it may be false. Be aware that if you transfer funds to foreign firms it may be very difficult or impossible to recover your funds. 7. Currency Scams Often Target Members of Ethnic Minorities Some currency trading scams target potential customers in ethnic communities, particularly persons in the Russian, Chinese and Indian immigrant communities, through advertisements in ethnic newspapers and television "infomercials." Sometimes those advertisements offer so-called "job opportunities" for "account executives" to trade foreign currencies. Be aware that "account executives" that are hired might be expected to use their own money for currency trading, as well as to recruit their family and friends to do likewise. What appears to be a promising job opportunity often is another way many of these companies lure customers into parting with their cash. 8. Be Sure You Get the Company's Performance Track Record Get as much information as possible about the firm's or individual's performance record on behalf of other clients. You should be aware, however, that It may be difficult or impossible to do so, or to verify the information you receive. While firms and individuals are not required to provide this information, you should be wary of any person who is not willing to do so or who provides you with incomplete information. However, keep in mind, even if you do receive a glossy brochure or sophisticated-looking charts, that the information they contain might be false. 9. Don't Deal With Anyone Who Won't Give You His Background Plan to do a lot of checking of any information you receive to be sure that the company is and does exactly what it says. Get the background of the persons running or promoting the company, if possible. Do not rely solely on oral statements or promises from the firm's employees. Ask for all information in written form. If you cannot satisfy yourself that the persons with whom you are dealing are completely legitimate and above-board, the wisest course of action is to avoid trading foreign currencies through those companies. The use of high leverage By offering high leverage, the market maker encourages traders to trade extremely large positions. This increases the trading volume cleared by the market maker and increases his profits, but increases the risk that the trader will receive a margin call. While professional currency dealers (banks, hedge funds) never use more than 10:1 leverage, retail clients are generally offered leverage between 50:1 and 200:1, and even up to 400:1. |
• 4/8/2007 - Forex scam
A forex scam is any trading scheme used to defraud individual traders by convincing them that they can expect to gain an unreasonably high profit by trading in the foreign exchange market, which would be a zero-sum game were it not for the fact that there are brokerage commissions, which technically make forex a "negative-sum" game.
These scams might include churning of customer accounts for the purpose of generating commissions, selling software that is supposed to guide the customer to large profits, improperly managed "managed accounts", false advertising, Ponzi schemes and outright fraud It also refers to any retail forex broker who indicates that trading foreign exchange is a low risk, high profit investment.
The U.S. Commodity Futures Trading Commission (CFTC), which loosely regulates the foreign exchange market in the United States, has noted an increase in the amount of unscrupulous activity in the non-bank foreign exchange industry.
An official of the National Futures Association was quoted as saying, "Retail forex trading has increased dramatically over the past few years. Unfortunately, the amount of forex fraud has also increased dramatically..." Between 2001 and 2006 the U.S. Commodity Futures Trading Commission has prosecuted more than 80 cases involving the defrauding of more than 23,000 customers who lost $300 million, mostly in managed accounts. CNN also quoted Godfried De Vidts, President of the Financial Markets Association, a European body, as saying, "Banks have a duty to protect their customers and they should make sure customers understand what they are doing. Now if people go online, on non-bank portals, how is this control being done?"
The highly technical nature of retail forex industry, the OTC nature of the market, and the loose regulation of the market, leaves retail speculators vulnerable. Defrauded traders and regulatory authorities, can find it very difficult to prove that market manipulation has occurred since there is no central currency market, but rather a number of more or less interconnected marketplaces provided by interbank market makers.
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