The Basics

It’s not your broker stop-hunting you

Stop-hunting is a very commonly discussed topic in the retail forex community – probably more so than it really deserves to be. It seems to come from a fundamental lack of understanding about how the markets operate. A prime example is a recent thread started on BabyPips where the poster asked if it was possible for ECN brokers to run stops.

Here’s the deal. Despite what some people would like you to believe – mostly because they refuse to accept blame for their own inability to perform in the markets – brokers do not make a habit of running customer stops. They really just pass prices through from the inter-bank market. ECN brokers don’t make markets at all (yes, there have been some cases of manipulation, but they are not nearly as prevalent as the blamers suggest). They just pass customer orders through into the market for execution in a way not dissimilar to the way stock or futures brokers operate. They have absolutely zero influence on the prices shown.

Stop-hunting, which really should be called order-hunting because they go after limit orders as well, happens in the inter-bank market. If the market price gets sufficiently close to a level where it is suspected that a high quantity of standing orders sit, certain types of traders from banks, hedge funds, etc. will attempt to get those orders triggered to benefit from the subsequent move.

Talk with anyone who’s been a professional trader in anything like a market maker or floor trader situation and they will have plenty of stories about stop-running. It happens in all markets, not just forex. The way to avoid it catching you out is to either not use standing orders or to place them at price levels away from chart points where a lot of other traders are likely to have their orders.

Trading News

New Players Make Forex More Competitive

The analysts at Citi and I are not the only ones thinking about the future of the retail foreign exchange business. Adam over at the Forex Blog had a post out over the weekend on the same subject. The potential expansion of a stock broker like Charles Schwab (following on the earlier move of TD Ameritrade into the space) could add another well capitized (and highly respected) player to the space, increasing competition for trader dollars. I will contest Adam’s suggestion that spreads in forex are “healthy” (see The Cost of Trading), but not his conclusion that more competition is likely to make trading more commoditized and transparent.

The interesting thing to watch is how the SEC vs. CTFC regulatory difference might come into play. Schwab and TD Ameritrade are securities brokers who fall under FINRA and the SEC, as opposed to the straight out retail forex brokers who fall under the oversight of the NFA and CFTC.

Trading News

Competition, Regulation Hitting Forex Brokers?

Apparently, the analysts at Citi have their concerns about the earnings prospects of the major forex retail brokers. They’ve knocked their price forecast for FXCM (which went public not to long ago) down to $18 from $14. Ouch! They’ve done this on the basis of the trading metrics FXCM has just reported for January. They didn’t quite meet expectations.

It’s interesting to note how aggressive things have gotten in the retail forex broker space where advertising in concerned. FXCM and Gain are co-sponsors for CNBC’s new forex program. FxPro is a lead sponsor for two teams in the top division of English soccer. Oanda has just started advertising after having taken a word-of-mouth approach to attracting customers for years. That means the account acquisition cost for these brokers has risen at the same time as new regulations like the CTFC’s 50:1 leverage limit are putting upside limits on how much volume those accounts can trade. It’s going to be interesting to see how the industry evolves from here.

One of the more interesting side benefits of having FXCM and Gain as listed stocks is that we get to see all kinds of data we would not have seen otherwise. One of those is volume data. FXCM reported $258bln in trading for the month of January. Gain reported $470bln for Q4 of 2010, $1.6trln for the full year. I’m thinking at some point it would be worth comparing that volume to comparable retail volume in other markets.

Trading News

Updated Forex Broker Customer Performance Figures

Back in October I posted on the newly released customer profitably statistics from retail forex brokers. The second update of those figures was recently posted, with both Forex Magnates and BabyPips posting tables with the numbers. The numbers getting the most attention are the 3000k+ rise in accounts for both FXCM and Gain Capital ( over the 3-month period in question. As I noted in my prior post, there was the expectation that accounts previously shifted overseas to avoid the NFA anti-hedging restrictions (see NFA rule which effectively bans the practice of “hedging”, NFA Justifications and Reasoning for Killing Forex Hedging, and New NFA Rule Impacts More Than Just Forex Hedging) would be brought back to US domicile. We need to see if account figures for those brokers are more stable moving forward to know whether repatriation is the cause there.

In terms of profitability, Oanda continues to be far and away the leader. They dipped slightly from 51% to 47%, but considering the next best broker in that category comes in at 32%, we’ll still call Oanda well ahead of the rest in terms of customer performance. In the “Annual Update” recently released by OANDA, they addressed the question of why they’re traders are seeing much more profitable performance:

There was considerable debate on why OANDA stood out from our competitors on the profitability numbers. From our point of view, our clients have several unique advantages. For example, we do not eat away at their balances with “non-activity” fees. We allow them to trade any amount, to better fit their trading strategies. We pay second-by-second interest on account balances, in contrast to some other brokers. But in the end, we believe the key advantages we offer our traders are quality of execution and tight spreads. Spreads are the effective cost of trading, and have a material difference on trading results. Many traders do not fully realize that a spread even one tenth of one pip lower can turn a profitable trading strategy into a non-profitable one.

These quarterly updates are just one of the ways the NFA and CFTC are attempting to make sure the US retail forex broker community is operating completely above board. Recently word came down about NFA to investigate all forex brokers for unfair trading practices. That one should be really interesting. As I noted on Facebook, that could either help improve the broker community’s external credibility, or totally destroy it.

Trader Resources

My Tools of the Trade

Trader Mike and Blain at StockToGo both posted recently on the various tools they use in their trading. I know I’ve talked about this before, but I figured it was worth revisiting the subject. Seeing as I work for one of the biggest information companies in the world (Thomson Reuters), I have access to all kinds of stuff. The jealousy factor among my peers is quite high. 🙂

At Work
For my daily work as a forex analyst I have four monitors running from one CPU. One of displays Thomson One, with which I keep track of the equity markets. Another screen has Reuters 3000 Xtra (haven’t updated yet to Eikon). That’s my primary data and news workhorse application. I’m mainly a technician, but I cannot ignore the fundamental side of things as I have to write about that as well. On a 3rd screen I have a version of MetaStock Professional to use some custom indicators, run the occasional screener or test, etc. My fourth monitor is my working screen, of course.

Among the other tools of my trade during the work day are Reuters Messenger (we’ve got Compliance limits on what IM apps we can use) for quick contact with colleagues and contacts, Feedly to keep track of a long list of blogs and news sites, and SnagIt for grabbing and editing charts and other graphics. All of our content creation and editing is web-based, for which I generally use Firefox. I also use Excel a fair bit, in many cases bringing data in (live and/or EOD) from Reuters or MetaStock (which is really the same data), either as a drag-and-drop or through a special plug-in. Seeing as I have a very geeky research-oriented side, Having access to all this data is very cool. 🙂

My own trading
In my work I have to follow the markets in real time and know what’s going on across the board all the time. For my own trading my needs are much, much less. In fact, I can generally get all the information I need from free and/or low cost sources, and I don’t need anything special on the computing side beyond a relatively modern machine and a high speed internet connection.

I have always done my stock and option trading with Charles Schwab (I may think about changing that this year), and have had plenty of access to information, screeners, and all the stuff I use in my equity market trading through their website and other tools. My other primary trading focus is forex, and for that I use Oanda’s fx Trade platform. The commonly expressed complaint about the Oanda platform is the lack of charting tools, but it’s got more than enough for my purposes as I don’t really need much more than a price chart. The one drawback for me is the lack of chart time frames above daily.

There are only three data/charting packages I have ever paid to use. One is Daily Graphs. Readers of The Essentials of Trading will know that I have long had the CANSLIM system as the underlying philosophy of my stock trading. I can get much of the same info through my broker, but using the Daily Graphs service can make the process quicker and more efficient.

I have also paid for MetaStock and Sierra Chart with IQ Feed data. Seeing as I work for the parent company of MetaStock now, I get the software and data free these days. I first started using it back in the middle 90s, however, and paid for the software and EOD data (didn’t need intraday, and still really don’t) for more than a decade as something to back-up the free charting I was getting through my broker accounts and to work on research ideas. In the case of Sierra Chart, it was strictly about price distribution charting (Market Profile/TPO). Sierra Chart is very reasonably priced and has some other nice features, like a replay function.

Beyond that, I’m probably pretty boring. I use Excel a great deal for performance tracking, data analysis and research. My knowledge of and experience with VBA makes it a powerful tool for me. That’s about it, though. I tend toward swing/position trading time frames, so I don’t need a lot of the decision-support help day trading can require.

Trading News

Retail Forex Trader Profitability and the Death of US Forex Trading

I initially wrote this for the Currensee blog on October 18th. I’m cross posting it here because I think it will be of considerable interest.

This is the first week under the new CFTC rules restricting leverage for holders of US retail forex trading accounts to 50:1 for the major trading pairs and 20:1 for minor ones (see Asaf’s post and an earlier one of mine on the subject). Obviously, there are implications for certain traders because of the change (probably not the vast majority, though), but one of the more interesting aspects of it all is the reporting the brokers must now do regarding the performance of their brokerage customers. They now have to disclose to new account holders the % of customers who have made and lost money. Forex Magnates has gotten hold of these reports for most of the brokers servicing the US customer base and presented the information from them here.

The common mantra in retail forex trading is that 95% of all traders fail. Of course we don’t really know what ‘fail’ means or over what time frame this is meant to cover. The figures from the brokers are equally subject to some “Yeah, but” type questioning. According to the Q3 figures, about 25% of brokerage customers are profitable, if you don’t include Oanda.

The problem we have here is that we really don’t know what these numbers mean in terms of long-run trader profitability. The % profitable figure is very likely to demonstrate a survivor bias whereby traders who crash and burn will eventually fall out of the study, as the reporting only includes accounts where trades have actually been made. Obviously, if you’ve lost all your money or become so disheartened by poor performance that you stop trading all together, you’re not going to be counted.

Then we have the question of Oanda, which shows WAY better customer profitability than the others. Are they using a different calculation methodology? Does the fact that they pay interest on your margin balance influence the reporting? I ask because an account that does no trades but still has a balance will end the quarter profitable because of the interest earned. I don’t know if those daily interest payments are transactions which make an account “active” or not. I’d love to hear from someone at Oanda whether that’s the case. If not, then we have a very significant question as to what makes Oanda customers more profitable. Is it somehow a function of the 50:1 leverage they’ve always had? If so, it starts to make the CFTC decision look a lot better.

The demise of US retail forex trading
The other thing we can look at in these reports is the actual number of active customer accounts each broker has. Folks have been howling about the pending destruction of the US forex business every since the NFA came through with its FIFO and no-hedging rules last year. The broker reports don’t go back that far, so we can’t see what impact was had where folks shipping their accounts overseas might have had, but since many of those accounts are now coming back, and will thus be included in the broker Q4 numbers we may get some idea.

We can perhaps get an idea what the CFTC leverage restrictions may have done to US broker accounts, though. The initial proposal of a 10:1 leverage limit hit the markets at the start of this year, with the announcement of the final 50:1 cap coming in August. The table below outlines the impact.

Notice that in the first quarter of the year there was a 5% reduction in active broker accounts. Thereafter, though, the decline has only been 1% in each of the last two quarters. I’m reluctant to call that any kind of major problem, and it will be very interesting to see if the forced-repatriation of accounts from foreign lands that is happening will actually result in a positive impact on the numbers for this quarter, especially for those brokers who have had the biggest drop in US accounts.

Again, we see Oanda as a major outlier. Rather than being about flat to lower in terms of customer accounts, it has seen a 20% rise in the last year. Considering Oanda does not do any marketing and has only every allowed a maximum 50:1 leverage, these are quite interesting figures. It leaves one to wonder if that reflects the fact that Oanda has no fixed lots, and thus allows very low capitalization customers to take part in the market without having to trade with very high leverage ratios. That’s just speculation at this point, though. We may never really know.

The point is that we probably haven’t seen the end for the US forex business, despite the doomsayers. We’ll want to wait to see the Q4 2010 figures for a better reading on customer accounts, though, because of those who would have moved accounts offshore away from CFTC oversight and those brought back from broker foreign affiliates.

Trading News

Trader Performance May Not Be as Bad as They Say

Here’s an interesting forex broker table posted at Forex Magnates. It lays out the % of profitable traders among its customers.

There’s considerable talk among retail traders that 95% of those who enter the forex market crash and burn. The figures above, which show the % of customers who have made money vs. lost money in a given quarter, would seem to suggest the 95% is an exaggeration. I’ve always felt that was likely the case, but keep a couple things in mind when looking at the information above.

First, % unprofitable, I believe, includes break-even accounts. That means folks who didn’t do any trading at all during the quarter would be counted as unprofitable. (Clarification: The broker has indicated that inactive accounts during the quarter were not included.)

Second, we have no indication of how profitable or unprofitable these traders are based on these figures. I bring this up because it could be the case that the profitable folks are only just and the unprofitable ones are very, or vice versa. We have no way of knowing.

Third, I don’t know how closed or blown-up accounts are accounted for here. One of the issues with performance metrics is the survivor bias. Is the % profitable simply a reflection of the fact that the unprofitable traders are churned out of the count?

Here’s something else worth considering. According to numbers I’ve seen from among live trading performance of members of one social trading network, 60% of all trades were profitable. They’re % of winning traders was comparable to what’s show in the table above. What’s the conclusion? Something I’ve said many times. Win % is not what determines trader performance.