There should be a sign hanging outside the forex market stating: Hobbyists do not need to apply.
Don’t be fooled by the sleepy nature of the currency world, where returns are typically measured in fractions of a percent. The popularity of leverage – borrowing money to amplify those small returns – makes it extremely dangerous for retail investors.
Just look at what happened last week when the Swiss franc soared after the country’s central bank shocked the world by removing a cap on the currency.
Not only did “smart money” on Wall Street lose, the brokerage houses that cater to retail currency investors were also crushed.
New York-based brokerage clients FXCM ( lost so much money that the company had over $ 200 million in the hole. The company received an emergency loan to cover its losses, but with a high interest rate. )
âAlmost any investment can be risky. Some, however, are riskier than others and may not be suitable for retail investors,â said Harvey Pitt, former chairman of the Securities and Exchange Commission. “Many retail investors simply had no idea of ââthis type of potential volatility.”
Related: Swiss Companies and Currency Brokers Are Bleeding
Dangerous game: The fallout from the Swiss currency shock continues to trickle down to financial markets. FXCM shares fell more than 87% on Tuesday, the first day they resumed trading since the company revealed its equity had been wiped out by massive customer losses.
FXCM’s financial woes were compounded by the fact that many of its clients used leverage.
“The FXCM situation demonstrates that playing with foreign currencies is an extremely dangerous game. It is not for the faint hearted,” said Anthony Sabino, professor at the University of St. John’s. “Fortunes can be made, but fortunes more often than not are destroyed.”
Related: One US Dollar May Soon Equal to One Euro
Paris complexes: Currency trading is not only very leveraged, it is also very difficult. According to the National Futures Association, nearly three-quarters of clients trading currencies through brokerage houses lose money and the average life of an account is only four months.
The trickier part of investing in forex is the fact that investors need to understand many factors, including vague statements from the central bank, local politics, and geopolitical threats.
âWhen you talk about currencies, the key word is ‘foreign’. Sitting in your living room in Oklahoma, it’s hard to gauge what’s going on there from a distance, âSabino said.
Even savvy Wall Street investors were completely caught off guard by the Swiss National Bank’s decision to remove its monetary peg. If smart money got it wrong, how are retail investors supposed to stand a chance?
âWhether you do it as a hobby or for a living, it’s a very dangerous environment to play in. It’s very difficult to make that macro bet and then increase it — and be good. side, âsaid Art Hogan, chief markets strategist at Wunderlich Securities.
These risks are magnified by the lack of a safety net for investors in the event of a business collapse, as FXCM nearly did. While equity investors are protected by a federal insurance fund, there is no insurance for the futures, options, and swaps that currency traders typically deal with.
CNNMoney (New York) First published on January 21, 2015: 3:06 am ET