Learn forex trading – selecting a broker

Events from a few weeks ago certainly show that there is rather more to learning to trade forex than just worrying about the entries and exits.

When the Swiss central bank abandoned its policy of limiting the value of the  Swiss Franc to 1.2 Euro it certainly highlighted the importance of choosing your broker carefully.

FXCM, one of the largest forex brokers in the world,  lost around $225 million on the subsequent move, Alpari filed for insolvency and IG index stated that they could be in the hole for around £30 million.

Interestingly other brokers sailed through the storm apparently  untouched and as usual there were several rumours of “unusual” transactions in the Swiss prior to the announcement.

The FXCM woes (and other brokers)  were caused by their policy of not pursuing clients for losses in their accounts that are in excess of deposited funds. With the high levels of leverage available in forex combined with sudden big “fast market”  moves  this becomes quiet possible. So if a FXCM client had $1,000 on deposit but sustained losses of $3,000 on the Swiss before FXCM closed him out then FXCM took the $2,000 loss onto their own books.

Alpari apparently followed the same policy. Other brokers such as Interactive Brokers have stated that they will pursue clients for the full extent of the losses tht they have incurred and I suspect that IG will do the same.

As a trader I guess you can argue the benefits of which broker to select  either way. Those that used Alpari  now have the inconvenience of getting their funds back and of  finding a new broker but have not lost their house ! whilst those with IB still have  a broker to take their orders but possibly no money left to trade with !

Certainly if I was the type of trader who trades very aggressively and makes maximum use of leverage (which of course I most definitely am not) I know which of those brokers I would be choosing for such trades !  I suspect the answer for those with sufficient funds is to have more than one broker and to put the high risk high leverage trades through a broker that picks up part of your losses  in the event of the next catastrophic  “Black Swan” event hitting your account.

Why did FXCM and the others not see this coming ?

Well it is a classic Black Swan event where I guess brokers completely underestimated the statistical likelihood of such an event occurring. I am sure their risk analysts carefully calculated that such an event was a one in 100 year event or even 1 in 1000 year event or whatever. In fact these sorts of events routinely occur much more frequently than statistical analyses suggest that they should. Think Long Term Capital Management  who had I think 2 Nobel price winning mathematicians on the board and they still managed to get it wrong.  It is at these extreme edges of unexpected events that any precision in  statistical analyses tends to break down  (just when you need it most !). This is exemplified by stock market crashes.  I have personally lived through at least two “once in 100 year”  stock market events (as subsequently calculated by the statisticians) and I can assure you that I am not 200 years old – just feel it some days.

A good book on this subject  is The Black Swan by NassimTaleb