In my yesterday’s market analysis, I explained a little about the strong, sudden and strange CHF cross currency pairs movement. The number of comments, emails, phone calls, text messages and… from traders, investors and also financial companies and brokers made me write a small post and clarify a few things about this event.
1. First of all, this strong movement was related to sudden, unexpected and unscheduled change in Libor Rate. Nobody expected this change, and there was no Libor Rate change listed in any of the economic calenders. Even the most famous brokers, financial companies, liquidity providers and and banks didn’t expect such a news release and change.
This is to answer those of you who commented that although we tell them that when they trade the long time frames they don’t have to check the news, still they’d better to do it to avoid such strong movements. It wouldn’t help if you did it, because as I mentioned Libor Rate change was not listed on any of the economic calenders in advance. It was listed only after the change and the big movement yesterday at 4:30am EST. Learn about Libor rate and its importance in the markets: LIBOR and Its Importance
Most of those whose accounts were wiped out are among day traders who were long with CHF cross currency pairs based on the shorter time frames long trade setups. Those who trade the longer time frames either had no positions (because there was no trade setup on the longer time frames), or were short because of the too strong short trade setups like what GBP/CHF formed on the daily chart. So once again it is proven that it is safer and better to trade the longer time frames.
2. Why they changed the Libor Rate and why this change caused such a strong movement doesn’t matter for us. It just happened (Libor Rate was used to be 0.25% since March 2009. Then it was cut to -0.25% on December 2014, and it was cut to -0.75% today).
Something that matters is that…
- What happens if such a sudden and strong movement wipes out your account? What happens if the stop loss or target orders don’t get triggered? Is it the broker responsibility to recover the loss? How do the brokers get affected by such movements?
- How often are we going to be faced with such disasters? Are we supposed to lose our accounts once in while because of similar issues?
So there are two things when events like this occur. One side is the broker, and the other side is you and your account.
The bad news is that if your account gets blown up because of the events like CHF most recent crisis, then not only your broker doesn’t take the responsibility, but also he is usually affected very badly and chances are they get bankrupt and get out of the business completely. As far as I have seen, this is something that is already happened even to some of the most famous brokers.
As you know there are two kinds of brokers. Market Maker brokers who don’t transfer your orders to any interbank, and ECN/STP brokers who route your orders to the interbanks also known as liquidity providers.
Market maker brokers lose money if you make profit, and visa versa. It means your loss is their profit and your profit is their loss. When events like yesterday’s CHF movement occur, if it wipes out most of traders accounts, market maker brokers feast. Easy money…
However, if such a movement causes the traders positions to become positive, then a market maker broker has two options. Either he has to pay the traders profit, or make an excuse and deny to do it.
It all depends on the case. Sometimes market maker brokers prefer to handle a small loss not to mess up with the clients. But sometimes the loss is much more than what they can handle. Therefore, they have to make an excuse not to pay the clients’ profits.
It is a different story with ECN/STP brokers. Your profit is not their loss, and your loss is not their profit. But the problem is when a sudden and too strong movement occurs, it usually causes most of the clients accounts to reach the margin call and stop out levels, and get wiped out, because usually most traders always have wrong positions. The bigger problem is that as the movement is too strong and sudden, stop loss orders don’t work, and even if a position doesn’t have any stop loss, the broker’s automatic system cannot close the position when the account reaches the stop out level. Therefore, the account will go to a negative balance. For example a +$5000 account becomes -$50,000.
Indeed, it is the trader who has to pay this $45,000 loss to the broker, but almost in all cases traders walk away and the broker cannot take this money from them. So, either the broker has to pay this money to the liquidity provider from his own pocket, or they have to face insolvency. This is something that happened to some of the brokers because of the yesterday’s CHF crisis as of writing this post.
What if such a movement causes you to make profit with your ECN/STP account?
Again, that is the broker’s problem. If they can take the profit from liquidity providers, then they will pay you. If the liquidity providers refuse to pay (because they are also in trouble because of the strong movement), then either the broker has to pay it from his own pocket to keep you happy, or refuse to pay your profit and make you file a complaint. However, as I already mentioned, usually most traders have a wrong position and the broker not only cannot pay the liquidity providers losses, but also cannot pay the profitable traders.
So if your account is gone, it is gone. And if your broker is down, it is down, and there is nothing you can do about.
Traders who didn’t have too big accounts, can easily start from the scratch with another broker. Although some brokers are out of the game for good, this is not the end of trading. New brokers always come and traders will keep on trading. But the other important question is are we going to lose our accounts every now and then because of these events?
The good news is NO. Such events are not supposed to be seen even once in ten years. Indeed, what you witnessed yesterday was the biggest FX shocker in years, and I don’t think we will ever see it in future.
However, let’s say it happens even once in 5 or 10 years. Is there anything we can do not to lose our accounts? Obviously, stop loss cannot do anything in this case. So what is the solution?
The solution is what I already told you in several occasions during the past several months that I have started writing on LuckScout:
- When you become a consistently profitable trader and you become able to repeat your success with your demo account, for 6 consecutive months at least, and so you decide to open a live account, you should open a live account with an as small as possible balance.
- Trade with this account and double your money first, no matter how long it takes.
- Withdraw your principal and keep on trading with the residual balance which is your profit indeed.
- Grow your account to a reasonable balance with the power of compound interest, and then withdraw the profit all at once.
- Repeat the same process over and over again.
Imagine I open a $10,000 account and double its balance first. Then I withdraw my $10,000 principal and keep on trading with the residual balance ($10,000) which is my profit in fact. Then I decide to withdraw $90,000 when the account balance turns into $100,000. But, yesterday’s tsunami occurs when I am at the middle of the way and the account balance is $50,000. Let’s say the account gets wiped out (of course this happens only when I have a position against the market movement). Or the broker gets out of the business and defaults to pay my money. So I don’t lose my hard earned capital. I only lose the profit I have made, plus the 15-30 minutes time I have spent to work on the account every day goes down the drain.
What if this $50,000 was from my retirement savings? What if it was the money I could not afford to lose?
Trading is not all about learning the techniques and taking the positions. What I explained above is even more important. Most traders always care about taking positions, having as many trade setups and making as many pips as possible, but the currency market ocean is not supposed to be calm and quiet all the time. You will be faced with tsunamis too and you have to get prepared for it.
Stay away from these kinds of disasters and don’t risk your hard-earned money. Use the markets to increase your wealth the right way: