Why Gain and Saxo deserve some extra credit

Author: Greg Michalowski | Category: News

***Note: It has been brought to my attention that Dukascopy, Activtrades, RoboForex and Admiral Markets lowered the leverage BEFORE the decision and also deserve extra credit for reducing exposure for their businesses and clients.

As the dust settles after the SNB decision to abandon the EURCHF peg, and the winners and losers are put in their respective buckets, there are clear winners in the retail brokerage community in my eyes  — Gain Capital, Saxo Bank and others who slashed leverage on EURCHF (and other CHF pairs) before the SNB move.

This is not to say that other brokers did not do a fine job in managing risk and the fallout from it.  Oanda for one receives praise for absolving negative balances (see: Oanda wins points for quickly forgiving negative balances).  They would not have done that if they were threatened as a business.

Other brokers have sounded the “all is ok/business as usual” signal  (see chart below and our coverage Broker news: SNB fall out news repository).

I am pleased that the fallout from this list is not worse, which suggests that your forex brokers did manage their business risks professionally, and that is good for the retail forex trader.  These black swan events have the potential of exposing the frauds in the market that impact the customer funds as well. The brokers that are listed as insolvent, have said that the customer funds are safe which is good.  Those that say it is “business as usual” are not saying they have not incurred losses to their businesses, they are simply saying the losses are manageable and therefore customer funds are therefore safe as well. Some may have even made money (most likely those that have a trading desk).

What separates Gain Capital and Saxo Bank

Although, it seems all is mostly ok in the brokerage community, what Gain and Saxo did was above and beyond as they protected their business and their customers at the same time.  How did they do it?  One way was by using leverage as a risk management tool for their business and in the process, their customers trading business as well.

Forex Magnates has a chart that updates broker losses.

Leverage is the devil that attracts the vulnerable, the weak and because of it,  it also attracts customer funds to a broker.  What do you see as an advantages to forex on most broker sites?  Leverage. I often ask why?

Leverage is a double edged sword. Yes it can work for you but it can work against you as well.  I see it in comments here on ForexLive.com from time to time.  When leverage works it is great. It is a drug. It is such a high. We hear about it.

When it goes against you, it is really painful. Crickets.

What did Gain Capital and Saxo specifically do that differentiated them from the rest?

They looked at the positions in EURCHF and made the judgement (mathematically derived), that their risk in EURCHF was too great given the portfolios overall forex risk and risk from the peg disappearing.

I doubt the model would have anticipated a 3500 pip move, but it could have been easily 1000 or 1500 pips (that was about the move up when the peg was established). Even at that – with leverage and customer account balances factored in as a cushion (a broker is protected until the balance goes negative) –  it likely flashed red flags to risk management teams.  The red flag was that client accounts would go below $0.

When client balances go into negative, the forex broker business becomes a debt collection business and a business that will require additional legal expenses in the process. That apparently is not what they wanted to do.

So instead of 50:1 they lowered the leverage to 20:1.  The implications of that were that client with less account balance than that required to hold the same position, would have to close at least part of the open position (and may have to liquidate the entire position).

For others with enough account balance, the position would chew up more trading capital and therefore might cause them to liquidate some or all of their position to get more in balance.

For yet others,  they might have been insulted that the broker was taking away what they deserved – that is the right to buy a leveraged amount against the 1.2000 level and reap the rewards when the market bounced. Those traders likely left Saxo and Gain for other less restrictive brokers who offered greater leverage.

At the end of the day, the brokers were likely better off because of their decisions, and in turn so were their clients.  Let’s hope that other brokers heed the model in the future as a way to keep them healthy and in turn keep the clients healthy as well. Leverage, after all,  is not the benefit most believe from the broker and the client perspective.

I also hope that regulators go and visit the people at Gain and Saxo, for advise as to what to monitor for imbalances.  Start there and see if the focus can be on the weak points (like EURCHF) versus a blanket slash of leverage across the board.  If all brokers slashed margin to 20:1 on EURCHF perhaps what happened this week, may not have been so epic.  Remember this was caused because of an artificial peg, and the abrupt taking away of that floor.  The leverage and large position was the offshoot of that peg.  Unfortunately, either you have a peg, or you don’t. Taking it away – especially in times of weak fundamentals – is a recipe for a disaster especially if there are large positions at risk.

The solutions may not likely end all risk. But, there is risk in any market.   It is however, a way to define and limit risk at the brokers, and in turn at the customer level as well.