Weakness in Retail Forex: Inherent risks of a single market maker structure OPEN FORUM

Date: October 21st, 2005 14:00GMT

Expert: Peter Rosentriech Author of 'Forex Revolution'

Topics:
- The role of counterparty risk in forex trading
- How counterparty risk might manifest itself
- Basic rules of caution

Who is Peter Rosentreich?
Peter Rosentreich is a principle and foreign exchange trader for Rose Stevons & Company, a boutique New York alternative investment firm specializing in providing retail clients with innovative, structured products. Mr. Rosenstreich has extensive experience in the retail Forex sector. He is licensed with a series 3, 7, and 63, and is registered with the NASD and National Futures Association as a Commodity Trading Advisor (CTA). Mr. Rosenstreich holds a BA in History from Clark University and an MBA from the City University of New York, Zicklin School of Business.

Speech Material:

Given recent developments in the investment world, it is critical to revisit and review the role of counterparty risk to the retail forex trader. In recent years counterparty risk, while still an important factor to institutional traders, has become less important to retail traders. Retail traders tend to choose a trading firm based on other factors such as spreads, cost and execution.

In a single market maker system, which is the mechanism utilized by most retail platforms, there is a heavy reliance on the creditworthiness of the counterparty. This is due to the fact the firm is handling the trade for some period of time. Either holding the currency in inventory or quickly offsetting the trade, but both ways exposing them to additional risk.

Discussion – Please post your questions it is vital that we hear what you have to say!

- The role of counterparty risk in forex trading
- How counterparty risk might manifest itself
- Basic rules of cautionmy the euro could fall apart !

Session Transcript:

FXstreet Moderator (Oct 21, 2005 10:09:59 AM)
Welcome all and thank you for attending this Special Open discussion..On the recent developments in the forex Industry Today we have Peter Rosentriech The author of the forex revolution to share his ojective views..

FXstreet Moderator (Oct 21, 2005 10:10:36 AM)
Weakness in Retail Forex: Inherent risks of a single market maker structure OPEN FORUM

FXstreet Moderator (Oct 21, 2005 10:11:16 AM)
Please begin posting now we need to hear your thoughts, concerns and questions regarding the recent events of last week..

Peter (Oct 21, 2005 10:12:12 AM)
Just like to start by saying good morning, afternoon and night where ever you are and thank you for attending.

Peter (Oct 21, 2005 10:12:36 AM)
I would also like to thanks Fx.streeet.com and Claire inparticular for allowing me to speak today and for providing a world class website.

Peter (Oct 21, 2005 10:12:58 AM)
Although this forum is timely, considering the news of the day, I don’t want to address the refco issue specifically.

Peter (Oct 21, 2005 10:13:18 AM)
But rather looks at the larger picture

Peter (Oct 21, 2005 10:13:44 AM)
This is because I don’t have all the information to make educated conclusions and

Peter (Oct 21, 2005 10:14:07 AM)
I have worked with refcofx and personally believe they were doing a solid job.

Peter (Oct 21, 2005 10:14:20 AM)
However, this topic still needs to be revisited.

Peter (Oct 21, 2005 10:14:58 AM)
I will keep my remarks brief so that we can open the floor

Peter (Oct 21, 2005 10:15:21 AM)
Before the Commodity Futures Modernization Act of 2000 which basicly gave the CFTC and NFA jurisdiction over the forex market

Peter (Oct 21, 2005 10:16:05 AM)
credit risk ( which I will be referring to it as counterparty risk and will explain next), was a real concern for traders.

Peter (Oct 21, 2005 10:16:28 AM)
Because the lawlessness of the forex market demand every trader to be extra diligent when picking trading partners.

Peter (Oct 21, 2005 10:16:51 AM)
But as CFMA took effect traders took some comfort that a regulatory body was protecting their interests.

Peter (Oct 21, 2005 10:17:23 AM)
And for good reason, fcms needed to provide a level of capitalization, complete separation of customer accounts and auditing oversight.

Peter (Oct 21, 2005 10:18:03 AM)
Traders began to focus on spreads, cost, execution, additional services

Peter (Oct 21, 2005 10:18:12 AM)
over counterparty risk

Peter (Oct 21, 2005 10:18:51 AM)
However, on the insitutional side counterparty risk has never taken a back seat

Peter (Oct 21, 2005 10:19:17 AM)
and still plays a critical role in choosing trades

Peter (Oct 21, 2005 10:20:05 AM)
And hopefully it will move back into focus for retail forex traders

Peter (Oct 21, 2005 10:20:57 AM)
Ok let me clarify something

Peter (Oct 21, 2005 10:21:05 AM)
Credit Risk: is the possibility that one side in a FOREX transaction may not honor their debt when the deal is taken.

Peter (Oct 21, 2005 10:21:21 AM)
This may happen when the counterparty declares insolvency for a variety of reason.

Peter (Oct 21, 2005 10:21:53 AM)
It could be quick market transitions or movements

Peter (Oct 21, 2005 10:22:14 AM)
poor risk management by the counter party

Peter (Oct 21, 2005 10:22:46 AM)
dealers

Peter (Oct 21, 2005 10:23:18 AM)
or something complete unrelated to the market

Peter (Oct 21, 2005 10:23:59 AM)
Credit risk can be minimized by dealing on regulated exchanges, which require members to be monitored for credit worthiness

Peter (Oct 21, 2005 10:24:32 AM)
However we all know that forex doent have that Luxury

Peter (Oct 21, 2005 10:25:41 AM)
In addition most forex traders use a single market maker

Peter (Oct 21, 2005 10:26:15 AM)
which subjects them to the conditions of a single counterparty

Peter (Oct 21, 2005 10:27:30 AM)
In the institituional market the use of carefully monitoring credit and/or usage of a prime broker system helps lessen risk

Peter (Oct 21, 2005 10:28:30 AM)
Two quick ways for a retail trader to atleast address the problem is 1.

Peter (Oct 21, 2005 10:29:04 AM)
look at the cftc website of capitalization requirments of their fcms

Peter (Oct 21, 2005 10:29:41 AM)
and 2. speak to there service reps regard specific risk management policy

Peter (Oct 21, 2005 10:30:19 AM)
most retail firms like to quickly offset trades with a counter party

Peter (Oct 21, 2005 10:31:03 AM)
so they will only assume risk for a split second

Peter (Oct 21, 2005 10:31:53 AM)
but we all know what a split second can do in this market

Peter (Oct 21, 2005 10:33:58 AM)
Some firms take the additional risk, while others match bids/ offers before taking trades

Peter (Oct 21, 2005 10:34:05 AM)
Speaking with a service rep will give you insight into exactly how the fcm handles risk

Peter (Oct 21, 2005 10:34:47 AM)
and will give you as a trader a little piece of mind

FXstreet Moderator (Oct 21, 2005 10:35:13 AM)
Thank you very much Peter, at this point lets open the floor to questions

FXstreet Moderator (Oct 21, 2005 10:35:20 AM)
Please begin posting now..

greek (Oct 21, 2005 10:36:27 AM)
I am a client of RefcoFx. They are operating under Chapter 11. I have my money stuck there. Is it possible to have lost it? i do not know the U.S legislation. Are they obliged to return my money? for the moment they delay any payment..

Peter (Oct 21, 2005 10:37:55 AM)
I didnt want to answer any questions about refco specificly since I have to basis

Peter (Oct 21, 2005 10:38:00 AM)
You should call

Peter (Oct 21, 2005 10:38:27 AM)
Sharon Pendelton at the NFA for regarding speciifc questions

Peter (Oct 21, 2005 10:39:29 AM)
It seems we are getting alot of refco questions

Peter (Oct 21, 2005 10:39:56 AM)
again please call Sharon Pendelton at the NFA for additional Info

FXstreet Moderator (Oct 21, 2005 10:40:58 AM)
(Preg question) Peter, I loved your book and I recommend it to everyone, experienced or not. I think it´s reasonable to be skeptical of your broker(s) but i also think it´s unhealthy to conjure up this distrust of them and think they are the enemy. What are your thoughts on this? For the record, I am not a broker.

Peter (Oct 21, 2005 10:41:25 AM)
hahaha

Peter (Oct 21, 2005 10:42:11 AM)
you are absolutely right. I personally have a love / hate relationship with my brokers over the years

Peter (Oct 21, 2005 10:43:19 AM)
but I also know what my objective and their objective are not always the same

Peter (Oct 21, 2005 10:43:53 AM)
remember in nature there are no true Symbiotic Relationships

FXstreet Moderator (Oct 21, 2005 10:44:57 AM)
Why would counterparty risk be important to the retail trader when take positions based on their market maker (retail platform) and have the retail platform take the risk against their counterparty?

Peter (Oct 21, 2005 10:46:04 AM)
Thats the core of this forum and a critical question

Peter (Oct 21, 2005 10:47:31 AM)
A trader has to realize that they might trade infrequently and take small positions

Peter (Oct 21, 2005 10:48:12 AM)
but remember some of these fcms have hundreds even thousand of cleints

Peter (Oct 21, 2005 10:48:17 AM)
all trading

Peter (Oct 21, 2005 10:48:31 AM)
the majors

Peter (Oct 21, 2005 10:49:17 AM)
Thats can add up to alot of risk

Peter (Oct 21, 2005 10:49:50 AM)
everything is nice when the market is at equalibrium or trending

Peter (Oct 21, 2005 10:51:01 AM)
but if one side falls out (liquidity crisis) and the fcm is stuck with to much risk

Peter (Oct 21, 2005 10:51:21 AM)
then it can become a major problem

Peter (Oct 21, 2005 10:53:03 AM)
And if the platform has assumed to much risk....the trade will be nulled

Peter (Oct 21, 2005 10:53:15 AM)
and that would be a kick in the butt

Peter (Oct 21, 2005 10:54:14 AM)
I think that most fcms have developed very sophisticated risk management strategies to protect themselves from such event

Peter (Oct 21, 2005 10:55:32 AM)
but it doesnt hurt for individuals to develop there own counter party risk strategies

JSB (Oct 21, 2005 10:56:43 AM)
In light of corporate accounting scandals in the past five years don't most trader feel that "auditing oversight" is worthless?

Peter (Oct 21, 2005 10:57:26 AM)
I have to admit, it makes it hard

Peter (Oct 21, 2005 10:58:55 AM)
I wouldnt say worthless but it makes me love my money management strategies that much important

Peter (Oct 21, 2005 10:59:46 AM)
Since these thing can come completely out of the blue regulating your down side risk is really your own protection

Bob_MA (Oct 21, 2005 11:00:05 AM)
It's my understanding that RefcoFX was not registered with the NFA due to some legal loopholes that Refco did when creating that unit. Does having a NFA and CFTC registered broker offer some guarantee that your money is not at risk?

Peter (Oct 21, 2005 11:00:40 AM)
The Donald "Trump" once said he picks a deal on the max down side, if he can handle the works downside loss then he can take the deal.

Peter (Oct 21, 2005 11:01:03 AM)
excuse me Worst downside

Peter (Oct 21, 2005 11:01:39 AM)
THERE ARE NO GUARANTEES in FX ever

Peter (Oct 21, 2005 11:01:51 AM)
ever, ever, ever

Peter (Oct 21, 2005 11:02:14 AM)
I dont care what any one says

Peter (Oct 21, 2005 11:03:19 AM)
But yes having an NFA and CFTC regulated broker (or another country designation)

Peter (Oct 21, 2005 11:03:27 AM)
adds some addtional protection

Peter (Oct 21, 2005 11:04:03 AM)
and as a basic rule of thumb I would trade with anyone without some level of oversight

Peter (Oct 21, 2005 11:04:17 AM)
WOULDNT

Peter (Oct 21, 2005 11:04:21 AM)
sorry tired

FXstreet Moderator (Oct 21, 2005 11:04:50 AM)
Last question

nader (Oct 21, 2005 11:04:54 AM)
do the orders actually make it to the interbank system or are they arll handled in house. and if so what size transactions would force them to pass through the order to the "interbank system"

Peter (Oct 21, 2005 11:05:43 AM)
Those are two great questions for your cleint rep and make sure they dont give you some canned

(Oct 21, 2005 11:06:05 AM)
Its critical to know the answer

Peter (Oct 21, 2005 11:07:19 AM)
I doubt many retail traders postions get passed of, for the most basic reason ther are addtional transations cost

Peter (Oct 21, 2005 11:08:00 AM)
the term "interbank" is a now a lossely used word

Peter (Oct 21, 2005 11:08:55 AM)
EBS a platform used by larger insitutions min is set at 1m

Peter (Oct 21, 2005 11:10:15 AM)
I sure most traders are trading at that unleveraged level

Peter (Oct 21, 2005 11:11:24 AM)
Hopefully one day retail traders will have the same access to a prime broker system that will allow them to choise there counterparty and trading partners

Peter (Oct 21, 2005 11:11:51 AM)
Thanks for attending and have a great, profitable day trading.

FXstreet Moderator (Oct 21, 2005 11:12:10 AM)
That’s all we have time for Today .Thank you very much for that, Peter for hosting this discussion at short notice.We at FXstreet.com hope you found it beneficial..

FXstreet Moderator (Oct 21, 2005 11:12:39 AM)
the link for the transcript and the PASSWORD will be posted. Link: http://www.fxstreet.com/chat/transcriptrequest.asp Password: Rosentriech187

FXstreet Moderator (Oct 21, 2005 11:12:57 AM)
Contact Peter at : prose@rosestevons.com

FXstreet Moderator (Oct 21, 2005 11:13:32 AM)
Thank you all see you all Monday for Live Perspective Broadcast with Derek Frey get your rundown for the week to come...

FXstreet Moderator (Oct 21, 2005 11:13:52 AM)
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