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Comment by comrade1 | Hacker News Reader

I don't think I understand how currency trading works. If you owned EUR the value of the EUR only changed relative to the CHF. If you owned CHF you gained 15% against all currencies.

How do people lose money on this? Are people somehow trading on the CHF/EUR exchange rate? And is so, why? The CHF was pegged to the EUR.

It reminds of when people were still trading shares in Genentech for years when Roche had an option to buy all GNE shares at a certain price, which they of course did eventually.

Is this another example of people trading without full knowledge?

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The issue is leverage. [1] [2] In order to trade $1mm worth of EUR vs CHF, you didn't actually have to have $1mm. So, if the CHF, for whatever reason, increased above the SNB peg of 1.2, you could then trade $1mm for, say, $10,000 in your account (100:1 leverage). Then, if there is a 1% move back to the Peg, you profit 0.01 x $1mm, or $1,000.

The reason brokers will give you this much leverage is that ForEx (up until a couple days ago) was one of the most liquid markets on the planet. If you hit a margin call, your broker could instantly liquidate your entire portfolio to cover any loss, with very little risk.

And then, the SNB walked away from their Peg, and the earth collapsed underneath all these traders (and brokers in some case) - All these traders/brokers who thought that a position could be liquidated at minimal loss, ran into a market with a scarcity (absence) of buyers, and were wiped for the entire value of their accounts (and more - lots of traders ended up with a negative position)

This is a wakeup call that people will remember or a very, very long time (and should have been learnt in the 2008 Mortgage collapse) - the potential for a black swan event is everywhere.

[1] http://www.investopedia.com/ask/answers/06/forexleverage.asp [2] http://www.investopedia.com/articles/forex/08/margin-leverag...

A 1% move would net you $10k, not $1k. That's why it's so alluring. You can gain (or lose) a lot when you're leveraged at 100:1 (as most retail FX brokers allow) and the currencies move just a small amount.

FX for the common man is recent. It's the new housing: access to leverage.

This makes me wonder. Aren't those retail investors all indebted to FXCM now ? They mostly made the bets using the platforms, (I assume) very little bets were made by FXCM itself.

Correct. "FXCM Inc. (FXCM), which handled a record $1.4 trillion of trades by individuals last quarter, said clients owe $225 million on their accounts after the Swiss National Bank’s decision to abandon the franc’s cap against the euro roiled markets worldwide." http://www.bloomberg.com/news/2015-01-16/fxcm-faces-losses-o...

Or if you have a FX-denominated mortgage (common in Hungary), you can have both!

I don't think this is a 'black swan' event. The strategy was pretty explicitly premised on a binary event: the Swiss bank keeping the peg or not. It didn't. As OP indicates, the possibility of the peg breaking was understood by anyone who actually understood the trades they were making. And it's not like central banks have never failed to keep a peg in the past...

A typical, very trading strategy was used by many people (including the biggest absolute return fund in my home country) and robots as well:

- CHFEUR floor is 1.2 (or that's what everybody thought)

- so you short the CHF @ 1.2

- side effect: your money is essentially stored safely in a position that has no downside but has upside (or so you think)

- if, for any reason, CHFEUR is >1.2, then you exit your short position with some profit

- when CHFEUR is back to 1.2, then do the same again.

Works brilliantly, until the black swan flies through your window, and everything is full of shattered glass. So in short, people relied on the SNB's promise, they thought there's zero risk of this thing happening (i.e. removing the floor without notice), and took positions that had small upside with ~1 probability and huge downside with ~0 probability. At least they have a good story to tell now.

So you are trading on the exchange rate? What's happening in the background? I guess someone is writing these option contracts and backing them with real currency?

In the background, the SNB was printing francs and purchasing Euro's to keep the EUR/CHF at the 1.2 Peg. They stopped doing that two days ago.

You can do that in many forms. You can go to a (daytrading) firm who either actually buys exactly what you tell them, or they pool up the clients' positions in some way to decrease their transaction costs. FX market is extremely liquid and fully automatized, settlement is usually done in batches but retail clients do not need to worry about that. Obviously there are contracts behind this, but there's no need to write a new contract every single time.

There are other forms of FX trading. For example, you can go to 'betting' sites to bet on currency rate movements -- for example, in the UK this is usually better for retail clients than normal FX trading as the profits fall under betting profits and not trading profits, and the former are lower. (Ridiculous, I know.)

In the background you have a loan in one currency, secured by the cash in the other currency.

What's happening in the background?

In lower-end forex shops, you're simply authorizing your broker to calculate how much money you would have won or lost had the trade actually occurred and debit/credit your account accordingly. No foreign currencies change hands and no financial instruments are implicated.

These are called "bucket shops" and they're so slimy that Bitcoin exchange operators feel obligated to describe that they're not like them.

Wow. The more things change, the more they stay the same.

More than a century ago, Jesse Livermore[1] made and lost several fortunes trading stocks via bucket shops. Not unlike what happens to current day card counters, the bucket shops banned Livermore. Bucket shops (at least for stocks) have long been illegal in the USA.

[1] https://en.wikipedia.org/wiki/Reminiscences_of_a_Stock_Opera...

What exactly is slimy about it? It's all based on a published exchange rate, right?

The original bucket shops were only slimy because they could have real traders at the exchange manipulating the price to wipe out customers in the bucket shop. (as far as I know)

To me, it seems slimy because the shop could find itself unable to pay out the money it owes to customers.

> I don't think I understand how currency trading works. If you owned EUR the value of the EUR only changed relative to the CHF. If you owned CHF you gained 15% against all currencies.

> How do people lose money on this? Are people somehow trading on the CHF/EUR exchange rate? And is so, why? The CHF was pegged to the EUR.

When you currency trade you go long one side of a currency pair and short the other. So you borrow 40000 Euro and buy Franc or vice versa. There is always a specific currency pair involved.

The usual reasons to take a position in a pegged currency is either to bet that the peg breaks (which people being long Euro obviously didn't do), or to extract value from a difference in interest rates (the carry trade, I don't know if that applied but there must have been something attractive about shorting CHF....)

Thanks. That makes sense to me.

In FX you are always trading one thing against another. There is a long position, and a short position. In this case, you were long EUR and short CHF. When CHF revalued 15%, you had to pay many more euros to buy back your short. So if you started with 100 EUR long, 120 CHF short, at the pre-break exchange rate of 1.2, then when it "cracked" to say 1.05, you had to pay 120/1.05 to repay your short. That's 114.2857 EUR you had to pay back, but you only had 100 EUR to start out. Thus you lost 14+%.

By the way, poorly explained in the main post: most of the stops actually happened way below 1.05. The cross panic-traded down to 0.85 in the hour after the reval announcement, which is where most of the stops were occurring.

1.2/0.85 - 1 = a 41% loss.

Imagine if you were leveraged 100x......

Alpari offered leverage up to 500x. Craziness.

As others already mentioned, you always trade currencies in pairs. By breaking the peg anyone on the wrong side of the pair lost. Since currencies move very little, most currency trades are highly leveraged. A 20% move in a day basically wiped out entire fortunes.

The other people who are exposed are those who took out swiss franc mortgages from other countries[1]. I'm amazed this was even allowed, but up until now the franc was stable and the rates low so it made some sense.

[1] http://www.economist.com/news/europe/21639760-poles-were-slo...

> It reminds of when people were still trading shares in Genentech for years when Roche had an option to buy all GNE shares at a certain price, which they of course did eventually.

Why do you think people would stop trading Genentech shares?

Because a lot of people including institutions like Goldman Sachs and the FX brokers were short-selling the CHF (selling borrowed CHF on the open market hoping to pay it back at a lower price denominated in another currency). Except the trade went against them because it was worth more denominated in other currencies. What I don't know myself though is how they were expecting it fall if it was pegged. Perhaps they announcement coming but thought it would fall in price instead of rise.

> I don't think I understand how currency trading works.

You're right, you don't, and it's too big a topic to explain in a comment, but basically yes people trade the exchange rates because they can and because if you do it right it's very profitable. You don't ever own either, currency trading is pairs trading where you're long one and short the other to open a position and exiting a position exits both trades which looks like a single trade to you.

George Soros once made a billion dollars shorting the GBP and forced a country to remove a floor, similar to what just happened here.

The EUR/USD has been sinking like a rock for most of the year, so traders short it, wait for it to sink more, and cash in their profits. It's just like trading stocks except you have more liquidity, more leverage, and going long/short are basically the same because these aren't stocks and going short the EUR/USD is identical to going long USD/EUR.

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