How Foreign Exchange Brokers Make Money by Luring Gullible Retail Investors

The number of  advertisements by Foreign Exchange Retail Trading Companies have increased dramatically in most of the popular Internet websites in India.These Websites try to lure potential retail suckers by showing pictures of ordinary people making regular monthly income by trading in Foreign Exchange.These ads are total misinformation as hardly any retail investor makes money from FX activity.FX trading is a complex activity at which even professional investors from bulge bracket financial institutions have a hard time in making money.Retail investors  always lose money in FX trading particularly as Foreign Exchange Trading is a zero sum game compared to equities.Huge amount of leverage makes attracting gullible investors even more easy.The FX retail trading platforms have proliferated in recent days with Retail Trading having multiplied by 900% in the last 10 years to around $100 billion daily.FXCM.com one of the popular trading platforms is coming out with an IPO in the US.These companies have benefited hugely on the back of suckering retail investors.Note these firms need a constant supply of new suckers (sorry customers) in order to run their companies.Here is a article from FT which describes the modus operandi of these firms taken right out of their handbook (IPO prospectus ).

Note these firms are heavily regulated and don’t do anything illegal,its just the lack of knowledge that results in retail investors losing money.These companies advertise heavily as can be made out from their huge sales/marketing expenses to gain new suckers for their casino.India too is now seeing increasing marketing spend from these companies offering high leverage and low expenses.Note most of the money is made by these FX brokers by providing opposing ask/bid to retail investors.They in turn get better bid/ask from wholesale firms allowing them to get a spread with almost zero risk.

The $100bn FX hustle – FT

The FOREX.com website, like the firm’s IPO prospectus, contains lots of warm words about enabling ordinary people to gain access to markets that were once the preserve of the professionals. There’s a stress on things like “education”,”managing risk in real time,” and other such intangibles.

The site also warns — in small print at the bottom of the page — that “forex trading involves significant risk of loss and is not suitable for all investors” and that “increasing leverage increases risk”. There’s also a separate page warning of the risks inherent to forex trading and the additional dangers of using an Internet-based platform.

Go to any of these sites — FXCM.com, Global Futures & Forex, Oanda.com, etc — and you will get the distinct impression that you are dealing with a warm-hearted, professional broker, where your interests are paramount.

But in many cases the exact opposite is the case.

Here’s how it works.

Our Madcap Speculator (MS), having been lured by an advert or other promotion, puts up $500 to “play the dollar.”  He thinks the dollar is going to 1.75 versus the Euro — and he may well be right, given that we’ve already moved from 1.25 to 1.50 in the past six months or so.

FXhustle.com offers the Madcap Speculator 200x leverage on his initial margin deposit of $500. That allows the client to go long the euro and short the dollar to the tune of $100,000.

Now, either because he’s cautious or because FXhustle have insisted he do so, our MS places a stop loss on his trade — limiting his total possible losses to $1,000.

Which is where FXhustle becomes the near-certain winner and Madcap Speculator becomes the likely loser.

MS might be right about dollar/euro going to $1.75, but even if it does, we can be absolutely certain that it will NOT do so in a straight line. And, because he’s levered 200 times, our little speculator cannot sustain much volatility without being stopped out.

FXhustle, on the other hand, acting as MS’s counterparty, can endure much greater price divergence — even without having a view on the future of the dollar.

In its role as counterparty, the firm is taking bets from tens of thousands of customers across dozens of currency pairs. It can maintain a neutral market position while banking the spread between wholesale FX rates and the quotes it offers the Speculators of this world. But it then sweeps up as soon as a client hits a stop loss — which the volatility in FX markets, together with excess leverage, makes a certainty.

With a simple algorithm covering market volatility and the leveraged state of clients, FXhustle can make near-certain returns — in just the same way that a casino takes a pre-defined cut at the roulette wheel.

The only trouble for FXhustle is that it needs to keep finding new Madcap Speculators willing to lose their money in this way.