From the April 01, 2008 issue of Futures Magazine • Subscribe!

The deepest market

A funny thing happened after launching the euro...foreign exchange trading opened up for retail traders and the long-term trends the currency markets were so well known for truncated. Volatility increased and trading these markets became a short-term trader’s mecca.

Currency trading has long been the domain of global banks and investment houses. Currency futures, which jump started the International Monetary Market at the Chicago Mercantile Exchange in the 1970s, were pretty much a non-starter with the big boys. No, the banks were focused on the over-the-counter markets, where trading currency pairs was common, and smaller currencies, like the ruble or baht or dinar, were accessed to make bigger returns. This was a market owned by the big trading firms of the financial world, and one rarely traded by the individual. In the case it was traded, it was typically by the larger commodity trading advisors, such as the likes of John W. Henry.

But that changed as dealer firms began forming that could consolidate smaller traders and attach them to larger trades. In the 1990s, this access grew slowly but surely until OTC forex firms opened to the retail trader. These firms offered something the on-exchange contracts could not: flexibility to trade the exotic currencies and the potential to play in the deepest, most liquid market in the world.

Forex firms started opening on every corner until regulators saw a new “bucket shop” pattern emerging and set higher capital requirements. Many of the weaker firms went out of business as a result; one firm, Refco Capital Management, had its own FX division that circumvented commodities regulations. The result was when the firm went under due to fraud, those FX clients lost their stakes and to this day have not received a penny of what’s owed them. This was another wake up call to the regulators, and to customers, who reviewed firms’ capital more closely, and also began looking at the exchange traded contracts more eagerly. When the currency futures went electronic, there was more incentive to use those products. There were more choices than in the early days, and customer funds were segregated. If a firm went under, it was likely customers would be safe. (Note the MF Global broker who lost $141 million trading the wheat futures market, and no customers were affected.)

Today the forex market thrives. Both OTC and futures contracts are traded by the large and small trader alike. Higher capital requirements for forex firms have largely chased bad apples out of the OTC market and the customers are better educated.

With the U.S. dollar hitting new lows, we dedicate this issue to the incredible foreign currency market that trades trillions of dollars per day. Almost every story in this issue touches on currencies and currency trading in some way, from our currency outlook (“The U.S. dollar and gravity’s pull”) to Trading Techniques (“From chaos to trends in forex,” “Safe profits with bull and bear stairs”), to Futures 101 (“Futures vs. forex”) to Managed Money (“Take the money and run”) that examines how patterns have changed in these markets and how the short-term trader is taking advantage of the volatility.

Last year while attending a retail forex conference, I asked some of the attendees how they got into the forex market and what they traded. I was a bit surprised that most had started off trading OTC currencies; many had not even traded a stock. They took a course, thought it sounded interesting and began trading Australian dollars, British pounds, etc. Perhaps I shouldn’t be surprised, as anyone who has done a currency conversion when traveling abroad does on a small scale what’s done in these markets: getting the best rate you can.

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