Over the weekend, one of the members of the SEC (Luis Aguilar) weighed in on the retail forex industry. The SEC commissioner issued a statement expressing his concern about retail forex fraud and about the risks associated with retail forex trading.
Some worry about what it might do to the retail forex industry as a whole.
Here are my initial thoughts on what we know right now.
First of all, the SEC doesn’t regulate retail forex — it’s the CFTC/NFA that does that. So the same people that regulate the commodities market regulate the retail forex market.
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So if the SEC weighs in, it will likely affect U.S. stock brokerage houses that deal in retail FX more so than a CFTC regulated forex broker like FXCM or Oanda.
Now, let’s first tackle the issue of fraud.
There’s no doubt that there is some fraud going on out there. However, I think we’re also seeing that fraud is “alive and well” in the stock market too (Hello, Madoff).
So maybe we sound issue a warning against investing in stocks because there are some fraudsters there too. Obviously that’s not practical.
Therefore, how do you go about avoiding fraud in the forex market? Trade with highly regulated and highly capitalized forex brokers such as FXCM, Oanda, GFT, Forex.com, etc. All of these brokers have deep pockets and meet all of the regulatory requirements of the U.S. regulators and all of the other countries that regulate them too (since these companies have international operations too).
Since there are a number of regulators that oversee these forex houses, it helps them to steer clear of fraudulent dealings.
Most of the fraud that is seen out there right now is an individual or smaller company that is blatantly trying to dodge the regulators. Well, that should be the first clue to not invest or trade through them.
So if you trade with the right forex companies you can avoid the fraudsters all together.
Next let’s address the risks.
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Back when I first started out in the forex industry, it was unregulated and you could have up to 400 to 1 leverage.
Almost six years later, the industry is regulated in many parts of the world and the leverage in most places has been reduced to 50 to 1.
Now I know this may still sound like “insane leverage”… but you have to remember that unlike a stock that may move 50 cents or a buck in one trading session … a currency pair may not move a full cent in one trading session.
In other words, the raw movement in currencies isn’t near as much as in stocks. What makes currencies more volatile is the added amplification of leverage.
However, there’s nothing that says that you have to use all of the leverage afforded to you either.
Let’s say you buy a 2011 Corvette Z06. They can do a quarter of a mile in just over 11 seconds with a top speed of 198 mph.
Now just because you have a car that has over 500 horsepower and can do almost 200 mph, do you have to drive that fast everywhere you go? Of course not! In fact, if you do, you’re likely to lose your license.
It’s the same way with retail forex trading. The major currency pairs and major cross pairs have 50 to 1 leverage. The exotic currencies have 20 to 1 leverage.
But you can choose how many lots you trade (or how much you step on the gas pedal) and not use all of the buying power that you have available to you. In fact, it wouldn’t be prudent to use most of the leverage available to you anyway.
So there are risks associated with trading this market just like there are risks in trading stocks on margin or in buying option contracts on stocks. All of these are leveraged ways to trade stocks which offer higher degrees of risk.
Therefore, while I feel the regulators will continue to put pressure on the forex industry, I don’t see it causing the retail forex industry to go away. (After all, if the industry goes away then they don’t have to pay regulators to oversee an industry that doesn’t exist.)
I believe these guys won’t run themselves out of a job. I know they love “big government” in all facets of the government.
So they’ll mainly “badger” the industry and make things difficult here and there…but I don’t think that it will slow down or stop the growth of the industry no more than it does the options market here in the U.S.
Both pose higher risk than non-margined stock investing … but they also offer the chance of outsized gains too.
Investors and traders alike just need to realize that they only want to allocate small percentages to riskier investments. They want to make sure that it is “risk capital” that they are trading and not their retirement funds, etc.
They need to realize that there’s no such thing as higher returns without higher risks taken…no matter what the financial asset that you’re talking about.
There’s a reason why a U.S. CD reaps less than 1 percent right about now and a stock averages 9 percent to 11 percent over time. There’s a higher degree of risk in owning the stock than the CD. The risk is higher but so is the potential for return.
The key is being comfortable with the risks and knowing what you’re getting into.
The retail forex market is a legit market. It’s just not for 100 percent of investors. But it is a way for many people to diversify outside of the U.S. dollar and it does give them another alternative to the U.S. stock market.
About the Author: Sean Hyman
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