Francogeddon: Lessons for currency traders, investors

By Jackie Cameronfrancogeddon

Francogeddon, the term being used to describe the havoc caused by the Swiss franc in currency markets last week, is a reminder that even the most seasoned investors can misread signals. After the Swiss central bank’s surprise announcement that it was lifting its ceiling against the euro, the franc shot up dramatically – leading to massive losses for traders who had bet that it would fall.

It wasn’t just currency traders who lost their shirts, though. Casualties of Francogeddon include Alpari, a retail forex trading operation with hundreds of thousands of clients which has gone under. And the share prices of many stocks listed in Zurich fell sharply, including luxury watchmakers Swatch and Richemont and private bank Julius Baer.

The sudden and dramatic strengthening of the Swiss Franc is also an unwelcome surprise for visitors to Switzerland. Tourism operators have lambasted the decision, saying accommodation, ski passes and eating out in the country immediately became 30% more expensive. Tourism numbers are expected to fall and the appetite for Swiss property is expected to wane.

The who’s who of global business – who were settling in for their annual World Economic Forum treat in Davos this weekend – are apparently less perturbed. The London-based Financial Times notes that delegates generally pay in advance and enjoy everything else “for free” during their stay.

Fund managers will this week, no doubt, be setting out the implications of Francogeddon for investors in collective investment schemes. Among the first to report back to clients was popular UK fund manager Woodford Investment Management LLP.

On Friday evening, it pointed out the implications for Swiss pharmaceuticals company Roche, which the Neil Woodford-managed fund holds.

“The Swiss franc currency position on the fund is unhedged…so in sterling terms, the dramatic appreciation of the Swiss franc actually translated into a modest net positive move for the fund. In sterling terms, the value of this Roche holding at close on 15 January 2015, increased from £134.7m to £138.4m, an increase of +2.7%,” it reassured investors.

While Woodford may be unusually talented, or lucky, many other investment professionals didn’t see Francogeddon coming. As the Financial Times says: even global policymakers were caught off guard by what it describes as an “out-of-the-blue” move.

This is partly because when the Swiss National Bank introduced the peg against the euro in 2011, it reportedly spent weeks in negotiations with the European Central Bank. It seems to have exited the peg without adequately informing its partners or Swiss politicians.

Francogeddon highlights the perils of betting in the currency markets. There’s big money to be made, and much more to be lost.

With the relaxation of exchange controls, it is easy these days to trade in currencies from South Africa.

The winner of Standard Bank Webtrader’s first global trading competition took the trophy late last year, for transforming a virtual US$100 000 to more than US$1,3m in 30 days, by aggressively trading in Spot FX. He said at the time he collected his cash prize he would never “gamble” with his own money, while BizNews visitors were quick to point out that “currency trading is gambling – nothing more”.

The collapse of Alpari shows that, unlike other gambling den operators, the house doesn’t always win in the casino of currency markets.

The big hazard with foreign currency trading is leverage, which is the ability to put down a small sum and borrow money to fund the balance of the deal – with a view to magnifying your return.

Unlike shares that go belly-up, when you buy on margin you can be asked to put more money into your account to cover losses. Says Standard Bank Webtrader: “Margin trading involves a large amount of risk. Since a position is being held that exceeds the actual value of the account, a trader could incur substantial losses if the market moves against his position.

“Thus, margin trading requires close monitoring of margin utilisation, i.e. the amount of collateral being used to hold margined positions. If margin utilisation exceeds collateral available for margin trading, positions must be closed, reduced, or additional funds must be posted immediately to cover the position,” it says.

In the US, the National Futures Association has imposed rules that brokers have to demonstrate large capital buffers and 50/1 leverage caps on trades, says FTWeekend. But elsewhere, regulators generally appear to have “failed to check the growth” of the foreign currency trading industry.

In Cyprus, leverage can rise to 1 000/1. And, in London, leverage levels of up to 500/1 are typically on offer to customers. The publication calls this a “glaring regulatory gap”, with spot forex trading not falling under the European markets rule book.

This, in turn, means that the UK regulatory Financial Conduct Authority only acts in cases of blatant fraud or scams. The FTWeekend calls this “an outrageous state of affairs”.

If you are determined to trade in global currency markets, know this: you are on your own and the risks are high.

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