Few short-term market events could be described as more shocking than the removal of the EUR/CHF peg that the SNB (Swiss National Bank) carried out today. This event sent shock-waves through the forex market, causing massive confusion, losses and problems that are very rarely seen in the most highly liquid market on the planet. The removal of the peg was like an earthquake for the market, causing extreme movements that were in many cases larger than the yearly ranges of the affected instruments. Through this post I want to talk about what the SNB did and how this event has taught current retail FX traders that they are trading a retail market where execution risks are not zero. I will be going through the event, my experience with it, the loses I took and how it has affected both small and big traders through the past 8 hours.
From 2011 the SNB had maintained the EUR/CHF exchange rate pegged at 1.20. This caused the SNB to accumulate massive international currency reserves as it bought EUR with CHF in an effort to defend the peg. This strategy worked for the past 3 years but with the advent of quantitative easing from the ECB it seemed daunting to continue holding this peg for much longer, as the accumulation of reserves would have been simply unsustainable. Since a peg is a golden opportunity for market arbitrage opportunities, the SNB clearly had no choice but to remove the peg without any warning, allowing the markets to establish a fair price for the EUR/CHF exchange rate (and all other CHF crosses) as a function of supply and demand.
When 95% of traders on a pair are holding long positions – thanks to the central bank “guarantee” that a floor won’t be breached – it is bound to be a blood bath when things unwind. This is what I expressed when I published an article in currency trader magazine last year, where I talked about a grid trading strategy to exploit long opportunities on this pair. Attempting to cash from this “guarantee” was a very profitable business for a while but it was never anything but an extremely high risk trade. You were buying with the hope that you would never see a price below 1.2000. The business became so profitable that many retail traders started to trade with extremely high leverages, attempting to scalp the pair for some profits every few days or weeks.
This is what happened to many traders holding positions on the EUR/CHF, however many retail traders did not count on the fact that every seller, needs a buyer. As the peg was released there was an immediate dry up of liquidity in the market (with even large banks like Deutsche and Citi having problems to get and fill orders). Who wants to trade an instrument that has not been priced by the market for more than 3 years? The answer, no one. After more than 1 hour with an almost zero liquidity buyers started to some in. This was at around the 2011 EUR/CHF lows, which are more than 2000 pips below the peg.
If you had a stop set below the peg, then the peg dropping meant that you would most likely not find a buyer when your SL was triggered. Many traders found out that their orders had been filled at -1000 pips, when their stop was just at 20, 50 or 100 pips. This happened across the board on all CHF instruments – not only the EUR/CHF – as the problem was now pricing the CHF to anything (not only the EUR). This meant that many traders with highly leveraged EUR/CHF long positions faced margin calls and – even worse – their accounts ended up in deeply negative territory as the exit price was simply much much much worse.
This reflects a potentially deep misunderstanding many retail traders have of how orders and leverage work. Stop orders are market orders which are not “guaranteed” to execute at any price, but are simply executed on the next best available price after the trigger happens. If you set your SL at 1.1990 it doesn’t mean that it will be executed at that price, but it means that it will be executed at the best price after 1.1990 arrives. If the next best price is 1.10, then that’s the price you get. Brokers cannot offer price levels that simply do not exist.
In the same sense, a margin call happens when the money in the account is lost (due to the leverage used). This triggers a stop for all the open positions at the next best available price. However – in the same fashion as the example showed above – if your exit is much more unfavorable than your trigger price then you can have a negative balance with the broker. The broker is also legally able to go after that negative balance because that’s clearly inscribed within the contract you sign when you decide to trade a highly leveraged product (you’re liable for it provided they can demonstrate no wrong doing on their part). This exact same thing can happen to brokers who had exposures that they needed to compensate, a broker that has orders from clients but is unable to hedge them with banks can be in the exact same position. Several retail brokers have already mentioned that they incurred multi-million dollar loses from the EUR/CHF peg removal. Whether they will or will not go after clients with negative balances remains to be seen.
When assessing the risk of trading positions we usually need to take into account all types of possible risk associated with them. One is the risk of the position going against us – the market risk – and another completely different risk is the execution risk, which is the risk associated with potentially not being able to liquidate the position at the desired prices. The Forex market – the most liquid market on the planet – is not immune to execution risks and trading highly leveraged products is never something you need to take lightly. This is the main reason why on my normal forex trading accounts I never take trades with positions that risk more than 0.2% risk per trade.
Trust me, I lost money too today (thankfully not too much) but I was definitely aware of all the risks involved. I also sized my trades such that the leverage used was never too high, such that I could definitely get out of the trades (even hundreds of pips below my SL, which was set at 1.1950) without the need to go into any significant negative balance. In the end I probably broke even between the profits and loses made through all this time (not the greatest deal in the end!) but it proved to me that being careful and properly accounting for all risk types is always worth it. It was a hell of a ride to attempt to profit from this EUR/CHF peg!
The SNB reminded us today of what it is like to trade a real market. There has to be a buyer for every seller and a seller for every buyer.
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