Is Foreign Exchange a new retail therapy?

It is big business in the UK, with 72,000 people playing the FX market as retail traders. Elizabeth Pfeuti reports


Foreign exchange markets are the Oxford Street of finance. Each week, millions of consumers use hundreds of trading partners and billions of pounds change hands.

Identifying your perfect FX trading partner may be likened to choosing your favourite shopping emporium in London’s West End. Do you want a dedicated, personalised service with help on hand at a moment’s notice or would you choose an outlet offering availability, discounts and a do-it-yourself attitude?

The retail FX business is mimicking the UK high street’s divergent approach as new traders come to the sector with very different expectations. As volatility has returned to financial markets, with the imminent withdrawal of quantitative easing, both sides are flourishing.

Some 72,000 people trade foreign exchange on retail accounts in the UK, according to Investment Trends, a trading and investment research firm. Global daily trading volumes have hit $5.3 trillion and the liquidity in the market far outstrips any other sector. Money can be made, and lost, in the blink of an eye, making it an increasingly attractive proposition in this low interest rate environment.

A quick internet search produces many pages of platforms encouraging retail customers to try currency trading, citing benefits of this market that never sleeps. But before signing up for an account, newcomers need to figure out which provides a service to fit their needs.

The first thing to consider is regulation, according to Jasper Lawler, market analyst at CMC Markets. “Only looking at those regulated by the Financial Conduct Authority already cuts the crop down,” he says. “What’s the point of trading if your money isn’t safe?”

Secondly, look at the spread you are paying. “Greater competition forces providers to up their game and can also drive down trading costs, which can be a positive thing for the retail trader,” says Joshua Raymond, chief market strategist at City Index. “On the other hand, we have seen a greater influx of smaller brokers who focus purely on getting clients through the door as opposed to providing them with a great trading experience.”

There is plenty to be said for this “pile ‘em high, sell ‘em cheap” experience – Oxford Street itself if bookended by flagship Primark stores – but for those who want a more customised experience, good news is at hand.

The market is becoming increasingly bi-polar, according to Pawel Rokicki, senior analyst at Investment Trends, as providers have begun to focus on specific client sectors. “The large, established leaders of the pack are targeting experienced traders,” he says. These players include IG, CMC Markets and City Index.

“This group is likely to have started with share investing, but have decided to move to FX as there is more to leverage,” says Mr Rokicki. Although all providers stress that there is no such thing as a typical client, City Index’s average patron is male, aged 35 to 45, with physical share-trading experience.

There is sound reasoning for targeting this market. Foreign exchange has always been a “margin” business and this group is likely to have larger pots of capital to allocate to FX trading while already understanding the concept of market risk.

Global distribution of retail fx volume

CUSTOMER LOYALTY

However, a sustainable business also needs customer loyalty and just offering the best price will not win it. Therefore, brokers are increasingly using a language this new breed of FX traders will understand.

“Our clients look for an extra level of service,” says Mr Lawler. “It goes beyond providing fundamental data; we offer technical analysis and educational services. We realise most people already have a day job so it makes sense to use a broker who understands what they’re doing and what they want, and are available at the end of a phone.”

The retail FX business is mimicking the UK high street’s divergent approach as new traders come to the sector with very different expectations

A well-established broker is also likely to have greater access to liquidity through a range of partners; this can help if a client is looking to leverage trades, which has become a popular option.

“They want to be in the game all the time,” says Mr Rokicki, “which means their provider also has to have the best mobile trading technology and a thirst for innovation.”

Innovation is expensive, making volume even more important, and all the while competition continues to increase.

On the last day of October, Gain Capital, the US-listed owner of UK retail FX broker Forex.com, announced it had bought City Index for $118 million. The firm is spreading its net outside the limited US market and is targeting the growing UK market.

UK brokers now face even tougher competition for top-end clients – service found in the boutiques of New York City’s Fifth Avenue.

WHAT IS SPREAD BETTING?

From horse racing to house prices, there is an active spread-betting market. But in the UK financial spread betting is one of the most popular ways to take a punt. In the 12 months to July, some 78,000 people actively participated, according to research firm Investment Trends.

Spread betting is the practice of predicting where the value or price of something will move – either up or down – and putting your mark on it.

This can be translated across all sectors. For example, if company X’s stock sits at 100 and the spread better thinks its value will go up, he or she goes long (buys) and cashes in when the stock rises. If the spread better thinks the price will go down, he or she goes short (sells) and takes the profit if the stock sinks. However, a movement against the bet results in losses.

Unlike physical investing, the spread better never owns anything, but instead uses a derivative, or financial instrument, to make the trade. This is done with a “margined product” that only requires the trader to deposit a small percentage of the full value of a position, which can be as little as 1 per cent of the value.

This can work well if the market goes the way you think, but you will be pushed to find the cash to fund losses if it doesn’t.

Recent low volatility in financial markets has caused a drop in the number of participants, but spread betting can be done on pretty much anything. However, knowledge of the market can help avoid costly mistakes.

WHAT ARE CFDS?

If you are considering breaking into contracts for difference (CFD), you will be joining the fastest growing trend in retail trading.

In July, 24,000 UK-based investors said they were actively using CFDs, with a further 16,000 expressing an interest to start, according to research firm Investment Trends.

City Index, one of the largest players in the UK market, explains a CFD as “an agreement between two parties to exchange the difference between the opening price and closing price of a contract”.

Unlike spread betting, CFD trading is confined to financial markets and is unavailable to some global market participants.

Instead of buying company stock, a derivative contract is created with a provider towards which a trader pays a small percentage of value. The trader either goes long (buys) if he or she predicts upwards movements or goes short (sells) if he or she thinks the share price will fall.

Due to this leveraging effect, a gain will see profit posted into the CFD trader’s account, but a loss means they will be called upon to fund the shortfall, which may be much larger than the initial deposit.

With capital gains tax implications, CFDs are used by physical share traders to offset either losses or wins in their portfolios by creating contracts that move the other way.

Traders can access global markets using CFDs, with an increasing number opting for individual share deals. Investment Trends found 47 per cent of CFD traders wanted single share contracts compared with just 16 per cent of spread betting traders, who preferred wider market exposure.

What are spread betting and CFDs

BIG DATA

EXPLORING NEW DIGITAL UNIVERSE

By the end of the decade, the digital universe will consist of almost as many digital bits as there are stars in the universe. It is doubling in size every two years and by 2020 the digital universe will reach 44 zettabytes or 44 trillion gigabytes, according to research by IDC.

High frequency trading, where traders can now deal in latencies measured in nanoseconds and microseconds as opposed to milliseconds and seconds, has been brought about by advances in computer processing speeds and major improvements in connectivity.

But the power of big data for trading is not all about speed. It is about the amount and type of data, and rapid analysis of it, that allows individuals to develop strategies to give them the edge when it comes to trading.

“The growth of this among hedge funds has been a natural evolution now that the pure speed focus has become somewhat old hat,” explains Chris Beauchamp of IG. “With technology now so powerful such an approach can bring rewards. Firms are looking to include social data or weather data, for example, in their strategies, something particularly applicable perhaps to commodity markets.”

So-called “sentiment analysis” can be powered by a big-data strategy to create a clear understanding of the mood of the market in order to drive trading strategies. Traders can use market commentators of their choice to establish their own positions. This can include the use of social media and blogs, as well as more traditional newswires and data feeds.

However, the big data journey has only just begun and Mr Beauchamp believes its utilisation by retail traders seems to be a way off. While they may be looking to exploit advantages, such as spotting and analysing tweets as they appear, such an approach would, however, require careful searching and also corroboration from other sources, which could easily slow down the process.