The Swissy Unpeg – Some Practical Lessons
by Gabriel Grammatidis
Due to the sudden SNB unpeg last month, traders who were short the Swissy might have incurred losses — and in some cases “fatal” losses. Traders, however, could have avoided such losses easily had they been following some general FX guidelines – guidelines that cannot be repeated too often:
- Don’t trade a pegged currency. (Corollary advice – Trade freely floating currencies.)
- Don’t trade an illiquid currency. (Stick with highly liquid pairs.)
- Don’t trade against the trend. (Trade with the trend.)
- Don’t trade high-risk low-profit ideas. (Find and trade only low-risk opportunities.)
Traders long the EURCHF pair who relied on the peg holding ignored all of the guidelines above. As a result, some of them (and even some funds) had to “bite the bullet” last month. Everybody can learn a number of lessons from this recent event including three specific areas this article is focusing on today — impact on FX brokerages, trading pegged pairs, and understanding FX instruments.
FX Brokerages Impact
It’s worth mentioning that for many months, most FX brokers had their clients’ interest in mind regarding CHF trading. Most had been warning their clients about the risks of the Swissy exposure and potential volatility. Many brokers had also taken the precautionary measure of increasing the minimum margin required for the CHF pairs from 1% to 5%. This change should have kept many clients out of the worst risk zone – and kept many brokerages out of trouble too.
Despite the sudden shakeup the SNB decision brought, the impact on the Forex Broker universe was relatively limited. Two brokers were affected the most by the recent SNB action – FXCM and Alpari (UK). Both brokers had a negative balance protection policy which means that clients could not lose more than the balance of their account (You can find a list of brokers that forgive negative balances here). FXCM has already balanced negative accounts related to this event.
Clients of FXCM and Alpari were also protected by the segregation of funds. This means that clients’ money was kept separate from the firms’ balance sheet as a protective measure – even in the bankruptcy of the broker. In the case of Alpari (which became insolvent), clients’ brokerage accounts were further legally protected by the UK’s government regulation for a deposit guarantee of up to 50 thousand Pounds.
Pegged FX Pairs
Are there other pegged currencies around? Yes, but only a few and FX traders should generally avoid trading them. None are very liquid: the Danish Krone, the Hong Kong Dollar and the Chinese Yuan Renminbi. Again, none of these currencies are attractive for active trading and should be avoided. (You can monitor which currencies are pegged with a little research at websites like this one.)
Forex offers traders a number of advantages and a primary benefit is a good number of tradable instruments or vehicles. The list of Forex instruments below is generally ordered from better longer-term holding periods to shortest term (from position to swing to intraday trading):
- Bank account denominated in a foreign exchange currency (eg CHF)
- Investment fund denominated in a foreign exchange currency (eg Bond fund in CHF)
- Currency swap (if provided by your bank)
- Currency ETF (eg leveraged CHF)
- Currency Options (eg EURCHF put with maturity in 2 years)
- Currency Futures or
- FX spot on margin
Some of the above instruments will better fit what you want to achieve in one situation while in another situation, a different type might be more suitable. The advantages and disadvantages of each vehicle over another can be both obvious and subtle so you should understand your objectives very thoroughly before considering the appropriate instruments for executing a strategy.
Short-Term Pain, Long-Term Gain?
As with many sudden events of this kind, initial effects may not be pleasant but the occurrence can turn out to be healthy for longer-term development. Ultimately, the SNB unpeg will probably promote more professionalism in the Forex trading industry. Too many market actors may have become too carefree and complacent after years of good business so the shock was indeed a very healthy development at the industry and market level. At the personal level, the Swissy unpeg was a remember for FX traders to focus on trading with the trend and trade the liquidity of currencies.
In upcoming articles, I will give some practical information on broker selection and also write about trading various instruments based on some higher time-frame patterns that are evolving.
All the best,