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Foreign currency brokers come under fire

August 5, 2011 | 11:34 am

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Companies that allow home investors to trade foreign currencies are coming under fire as regulators consider whether to put more rules on the fast-growing but risky market.

Currency brokers allow ordinary Americans to speculate on the value of dollars, euros and yen, and have grown revenue 374% since 2007, drawing in 615,000 American traders, according to the Aite Group consulting firm.

The most intense recent criticism of these brokers came from a hedge fund manager who researches and invests in companies that cater to home investors.

Justin Hughes, the founding partner of San Francisco-based Philadelphia Financial, said in a letter to the Securities and Exchange Commission that, according to his research, the average home currency trader loses all of his or her money within a year.

"We believe most retail [currency] traders would have superior results 'speculating' in Vegas rather than through retail [currency trading]," Hughes wrote in his Tuesday letter, which called for the SEC to ban home investors from the market.

Two of the leading currency trading firms criticized Hughes' analysis and noted that he has placed short bets against their companies and would benefit if the companies do poorly.

"It is false to characterize forex trading as a game of chance," said Glenn Stevens, the chief executive of Gain Capital Holdings Inc. "Like trading any other financial market, forex trading requires training, skill and discipline."

Hughes said that he was betting against the companies because of what he has discovered in his research.

"If McDonald's sold hamburgers that gave people food poisoning, would you own that stock or short it? I’d short it," Hughes said. "This is financial food poisoning." . . .

Hughes' letter was in response to the SEC’s recent request for comments on temporary rules that it put in place to govern foreign currency trading.

When the SEC put the rules in place last month, it took the unusual step of releasing an alert warning investors about the dangers of investing in foreign currencies.

“The only funds that you should put at risk when speculating in foreign currency are those funds that you can afford to lose entirely," the alert said. 

Foreign currency trading is regulated more lightly than other investment opportunities available to home investors, in part because it does not trade on an open exchange like stocks and commodities. Losses are amplified quickly because foreign currency traders are able to leverage their bets on a 50-1 ratio, as The Times detailed in an April story.

Regulators have recently tried to gain control over the market, and the SEC put its temporary rules in place until next summer while it considers how to regulate the market moving forward.

Statistics that currency brokers have been forced to release since last year indicate that close to 75% of all foreign currency traders in the U.S. end up losing money. Hughes, in his letter, compared this to casino blackjack players, who only lose 58% of the time.

A spokeswoman for FXCM, the largest U.S. retail currency broker, said that Hughes was making misleading comparisons.

"While it’s true that many day traders lose money, this is the case in every financial instrument, yet day trading is widely permissible in stocks and futures," said Jaclyn Sales, the spokeswoman.

The SEC has also received letters from home traders who begged the regulatory agency to keep the practice legal.

"This is a difficult business to succeed in as many fail," an Alabama resident wrote. "But, it can be done. There are many individual investors that do develop the skills and talents to succeed as a retail forex trader."

RELATED:

Foreign currency trading is easy

Foreign currency trading: An example

Trashing the dollar to save the economy

-- Nathaniel Popper

Photo: A currency exchange in Australia. Credit: Jeremy Piper / Associated Press

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