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Monday February 2, 2015 - 13:48:07 GMT
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Swiss franc jump shows the fine line between success and failure

Currencies, particularly those of well-run developed economies, seldom move very much.

 

The major forex pairs such as GBP/USD, USD/JPY, USD/CHF, EUR/USD often move no more than a few basis points a day (where one basis point equates to a 0.01% move).

 

However, they do move constantly and continuously. The forex market is open to traders 24 hours a day for five days out of seven and this means that currencies are perfect for those wishing to have a bet on the markets.

 

The problem is, because they only move very small amounts, traders must use huge amounts of leverage in order to make it worth their while. After all, if a trader bets $100 on GBP/USD and the currency goes up by 0.03%, she would have made less than a dollar in profit.

 

The solution provided by brokers is to give traders leverage of 50, 100, even 400 to 1. In this way, your $100 can suddenly control as much as $40,000 in the market and your estimated profit or loss is also magnified.

 

The Swiss franc

 

Last month, on the 15th of January, the currency markets moved away from their typical habitat of stability.

 

Instead of the usual movement of just 0.01-0.03% a day, the Swiss franc soared by over 30% in a matter of seconds as it was announced by the Swiss National Bank, that the three year-old peg to keep the currency locked in-step with the euro would be abandoned.

 

It was a move that nobody had predicted (although Saxo Bank did issue somewhat of a warning back in September of last year) and it took the entire forex market by surprise.

 

Over the previous three years, the Swiss franc had kept within an extremely tight range of just 2-3% as the SNB maintained just enough selling of itís own francs to keep the currency pegged to the euro at around the 1.20 level.

 

And, because of this supposed stability, the Swiss franc was seen as the perfect hedge by currency traders around the world. Looking to buy dollars and sell the euro? Easy, just hedge some of that exposure with a position in EURCHF.

 

For a very long time, traders made this play, knowing that there was next to no chance of EURCHF moving much more than a few percent. The assumed chance was small, but when this event did finally take place, you can imagine, there were a number of red faces around.

 

The fallout

 

While there were winners from the Swiss franc fallout, it was the losers who made the biggest noise, not least because of the number of traders who saw the Swiss franc as a Ďsure thingí.

 

According to forex broker FXCM, itís clients collectively owe around $225 million following the SNB decision while IG Group estimated the cost to the business at £30 million.

 

The truth is, FXCM and IG were among the lucky ones. UK broker Alpari said it had entered insolvency and in New Zealand, Excel Markets followed a similar fate. Countless individuals lost all their capital (and more) and no doubt there will be more casualties to follow.

 

The black swan

 

Nassim Taleb, author of The Black Swan, taught us that humans have a tendency to find simple explanations for long tail events, but that we do so only in hindsight. And David Hand taught us that improbable outcomes occur much more often than we would think.

 

By any stretch of the imagination, the movements of the Swiss franc on the 15th January can be classed as a black swan event.

 

Itís true that for every loser in the forex market there is a winner, but in this case, those who were unprepared for the improbable found out very quickly, the very fine line between success and failure.

 

 

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