Matt Levine explains how FXCM, Alpari, et. al. screwed up.

[randomness]

Matt Levine has an entertaining piece in Bloomberg View on how all those brokers lost all that money when their retail speculators were losing their shirts:

Imagine being a retail foreign-exchange broker and letting your customers day-trade Swiss francs with lots of leverage. How much leverage would you feel comfortable giving them? Well, if daily moves are typically less than 0.1 percent, then that means that 95 percent of the time their positions will move by less than 0.2 percent in a day. So if you required 2 percent margin -- that is, you demand $2 of cash from them for every $100 worth of Swiss francs that they trade -- you'd feel pretty safe. That would mean that, 95 percent of the time, customers couldn't lose more than one-tenth of their equity in a day -- so if they lost money and skipped out on you, you'd be able to liquidate their positions without getting close to losing any of the money you'd lent them.

On the other hand when the euro/franc moves by 19 percent in a day, they're gonna get utterly smoked, and so are you. This is roughly the boat in which FXCM Inc. finds itself.

...

It's good to occasionally remember that a margin loan is a put: If you let your customer buy something for $100, and you lend them $98 of the purchase price, and then the price of the thing falls to $81, then guess what, you own the thing! Also you've lost $17. I mean, you can call the customer and ask for more money, it can't hurt. But you're not going to, like, feel full of joy and confidence while you're making that phone call.

Comments

[achinhibitor.livejournal.com]

There's more to it than that. At this time, the SNB was trying to prevent the CHF from rising against the Euro, despite that all the fundamentals were driving the CHF up. The problem with such pressures is that they often follow the pattern of increasing pressure from the fundamentals being met with increasing pressure from whoever is intervening... Eventually the pressure becomes too much to resist, either because the costs to the intervenor become higher than the intervenor is willing to bear, or the intervenor runs out of power to intervene with enough force. At that point, the market very quickly snaps to approximately where it would have been on that date if the intervention had not been done at all, i.e., a huge making-up of change. Worse, as the situation develops, all the smart money starts betting on the ending of the intervention, which tends to increase the pressure on the intervenor, causing the end of intervention to come earlier than the fundamentals would lead you to expect.

This is the typical pattern for the breaking of currency pegs.

The subtlety in this case seems to be that in the early phases of the intervention, the CHF was being driven by panicked flow of money from the eurozone, and so the SNB could expect that after a few months the money flows would naturally reverse, and the CHF/EUR exchange would go back to what it was. But the pressure transitioned from being panic-driven to being driven by the fundamentals (the continuing weakness of the eurozone economies), which moved the intervention into the long-term-unsustainable category.

Of course, it's still hard to make money on this unless you have a few billion that you can invest for a few years, and go short on EUR and long on CHF.