The Last Look…
Posted by Colin Lambert. Last updated: October 25, 2021
The blurred lines between retail and wholesale FX markets have long bothered me, mainly because I see problems involving the former potentially spilling over into the other and leading to onerous and unnecessary regulation.
A few friends of mine and I have been debating the chances of a retail “army” influencing FX markets the way they have certain meme stocks and, perhaps to a lesser degree in recent months, crypto markets.
The general consensus is the obscurity of the trading book is FX’ biggest defence against concerted efforts to move the market – in equity markets with positions and orders published, vulnerabilities are easier to spot – that is not to say it can’t happen, however. Underpinning this debate, however, exactly what constitutes retail?
Several people I talk to believe that much of the prime-of-prime space is retail-orientated and don’t get me started on the number of platforms who believe the size of the trade is what makes a client “institutional” when in reality a retail trader with huge leverage is actually behind it.
Some brokers do undoubtedly masquerade as institutional because not only do they think it sounds better, but they also believe they can avoid unwelcome regulatory scrutiny in those jurisdictions with a casual approach to oversight. A lot of prime-of-primes, however service an important segment of our industry – those smaller hedge funds who simply cannot get a major player to prime broke them.
An area that I haven’t thought about much, but was raised by a friend recently, is mirror trading. This is, in my mind, heavily associated with retail FX and as such any firm providing such a service should be identified as just that. Mirror trading is another thing that has always bothered me, especially around disclosures and what happens if the “star” trader suddenly goes cold? People have very different abilities to absorb losses, should there be more attention paid to this?
Looking at recent events in equity and, to a degree, crypto markets, I am sure that a lot of retail punters are very happy to mirror trade or, more likely, be on a social media platform where they can get together and plan a trading strategy. Of course, if institutional players were to do this you can imagine the uproar, but in retail land it’s apparently not a problem, and this type of trading is now a staple of the retail scene.
I have often wondered what happens if, probably when, such a strategy goes wrong; and in Australia at least, we have a hint in a recent court case where an individual took a “finluencer” to court and won nearly $500,000. I struggle to come to terms with the concept that someone is going to invest serious amounts of money according to advice from an individual who offers little more than a boast about their abilities (or is mainly an expert in selfies). It’s called ‘due diligence’ people, but in retail land they don’t seem to understand the concept – I could drape myself over a flash car in front of a mansion and shout how I earned it all from trading Cable, but surely someone ought to actually be verifying the facts?
On social media, it’s difficult of course and as one of my friends is fond of observing, “a mug and his money will quickly be separated”, but for those firms offering mirror trading more can be done. I looked up three mirror trading service providers and while there seems to be a good amount of analytics available about how different strategies are performing, at no point was it obvious (or mentioned) how you access a detailed background of the “star” trader.
At first I couldn’t work out how the proceeds from mug punters in retail land found their way into points in the wholesale market, but as it turned out it was pretty easy
Several tout that their clients will be using algo trading systems similar to those used by hedge funds and banks. All I can say to that is the circumstances are rather different – the banks in particular are dealing with a vast amount more meaningful information, data that is driving their trading and execution decisions. That is very different to someone with a strategy populated by data from a platform that sees about 0.0000001% of flow.
In reality, when I managed to find someone who once tried mirror trading, the “strategies” are more often than not arbitrage, or ‘scalping’ plays, which work well for the most part, but when they go wrong they often lead to a wipeout. This means, my source tells me, that firms offering mirror trading services can point to a high percentage of winning trades, but maybe are less than forthcoming about the 5% that gives all the profit back and more.
What happens in the retail FX world should have little to do with the institutional market, but as lines blur, and amounts get larger (and more large firms offer a brokerage style service rather than risk absorption) it worries me that a catastrophe in retail land will work its way into the wholesale market. The only way to avoid this is greater inspection of where liquidity goes from the wholesale market – it has to get into the retail world somewhere, how well is it monitored?
Quite a few people don’t see this as an issue and think that the boundaries are firm enough to prevent this, but I still recall the FBI’s sting in the early years of this century, Operation Wooden Nickel. At first I couldn’t work out how the proceeds from mug punters in retail land found their way into points in the wholesale market, but as it turned out it was pretty easy – all it needed was one connection.
If that is still the case, it would be nice to have those at the top start to ask some serious questions of their downstream users – not least, what are you actually doing with my valuable liquidity?