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Foreign currency trading is easy — an easy way to lose money

More and more Americans are dabbling in currency trading and losing in spectacular fashion. Experts say the structure of the currency market makes it hard for amateurs to beat the house.

April 03, 2011|By Nathaniel Popper, Los Angeles Times
(Dave Wheeler, For The Times )

Reporting from New York — Dorothy Ouma began trading foreign currencies after seeing a TV commercial touting it as a way to make extra money, something she could use as a single mother raising three children.

"The ads made me think, 'This is easy,'" said Ouma, 52, an administrator with the Grand Prairie, Texas, police department.

Ouma used her credit card to fund an account with an online currency broker. Within a few weeks of swapping dollars for yen and euros, she said, her $3,000 of borrowed money was gone.

"Even if you make money for a little while, eventually you just end up losing," she said.

Ouma made two mistakes: investing on credit and trying to make a buck by predicting changes in currency exchange rates, something best left to professionals, according to personal finance experts. But she has plenty of company.

An estimated 615,000 Americans are dabbling in foreign currency trading, encouraged by advertising from the two biggest U.S. brokers, FXCM Inc. and Gain Capital Holdings Inc., both based in New York.

Combined, FXCM and Gain have about 260,000 accounts, a third of them in the U.S.

These customers are losing money in spectacular fashion.

At FXCM, 75% to 77% of customers lost money each quarter last year, according to newly required disclosures to the Commodity Futures Trading Commission. At Gain, which operates through http://www.forex.com, the number of unprofitable customers hovered between 72% and 79% every quarter last year, according to its filing.

Lots of leverage, lots of turnover

As if those statistics weren't scary enough, the rules of currency trading allow investors to leverage every dollar they bet on a 50-to-1 ratio. This allows them to bet money they don't have — a tactic that can boost profits but also losses.

The losses have triggered recent lawsuits and regulatory scrutiny — but haven't stopped the swift growth of the industry, which barely existed a decade ago. Gain and FXCM went public on the New York Stock Exchange last December.

Executives with both firms say that they simply provide a conduit for people who want to trade currency, and that customers are given full disclosure of the risk.

"The majority of people today are on a quarterly basis not doing well," Drew Niv, FXCM's chief executive, acknowledged in an interview. "There's lots of education showing, 'Here's how to do it right.' … Do most people heed the advice? No, of course not."

Trading experts, however, argue that the companies use aggressive advertising to lure inexperienced investors into an unusually opaque market.

"The business model for forex trading is to burn the customer and then find another one," said Larry Harris, a USC professor and the former chief economist at the Securities and Exchange Commission.

FXCM's own statistics show that its customer turnover is about four times higher than that of an ordinary retail stock broker. Gain does not release turnover statistics, but its securities filings show that most of its customers at the end of last year were different from the ones it started with, also suggesting high turnover.

'At the mercy of the dealer'

Experts say the unusual structure of the currency market makes it hard for amateurs to beat the house.

With stocks, brokerages typically send customer orders out to be executed at an independent exchange and charge a set commission for each trade, no matter whether the customer wins or loses.

That's not the case in foreign currency markets. Because there is no centralized currency exchange, the brokers must fill customer orders themselves. This enables them to make money in two ways.

The first is by buying a currency at one price and selling it at a higher price — netting the so-called spread between the two. Unlike the set commissions charged by stockbrokers, these spreads can be set at whatever level the currency broker chooses.

The second way the broker-dealers make money is by sitting on the opposite side of every customer trade, like a blackjack dealer sitting across from a gambler.

For instance, suppose a customer buys 10,000 euros at $1.45 each and sells them back to the broker at $1.50 apiece. That would net the customer a profit of $500 — and give the currency dealer a loss of $500.

More commonly, however, it's the customers who lose out on these transactions, despite required disclosure statements that warn investors: "Your dealer is your trading partner, which is a direct conflict of interest."

Gain ended up making an average of $2,913 from every active trader it had last year, even though the average customer account contained only $3,000, according to the company's financial data.

FXCM made $2,641 for every active trader, while the average customer had $3,658.

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