theskeptic's Journal: Currency Trading Is Moving From Brokers to Home Offices

Currency Trading Is Moving
From Brokers to Home Offices

By NAUREEN S. MALIK
THE WALL STREET JOURNAL ONLINE
November 25, 2004 11:52 p.m.

Every morning, Paul Sullivan dives in, climbs the wave slowly and hangs on for as long as he can. He takes his lumps and is back at it the next morning.

Surfer? No. He's part of an emerging group of stay-at-home traders rolling the dice to make money in the foreign-exchange market.

After sliding to an all-time low against the euro last week, the dollar is commanding more attention from economists and policy wonks. But Average Joe investors looking to play the currency market haven't always had an easy time getting in the front door. Electronic trading is changing that.

The foreign-exchange market primarily has been a proving ground for only sophisticated institutional investors, says Phillip Fondren, executive vice president of Refco F-X Associates LLC, the currency-brokerage unit of Refco Group Ltd. in New York. But technological advances and better protections have helped make the market much more understandable -- and accessible -- to individual retail investors.

Mr. Sullivan, a 45-year-old lifelong "entrepreneur" who works out of his home in Quincy, Mass., switched to currency trading two years ago "in search for a challenge." He now counts it as one of his primary sources of income. "My girlfriend thinks I spend too much time trading," says Mr. Sullivan, who wakes at 5:30 a.m. to cover trading hours in London and then New York. But nothing else provides "the thrill, the challenge and the monetary returns."

How big is this market? An estimated $1.9 trillion in currency changes daily, according to a triennial survey of 52 countries released in October by the Bank for International Settlements. That eclipsed $1.5 trillion daily in 1998, back during the inflating Internet bubble. (By comparison, average daily volume on the New York Stock Exchange has been $45 billion in 2004, so far.)

Individuals' share of the currency market, to be sure, is still marginal, says Jason Daw, Merrill Lynch's currency strategist. "It's a long way from becoming something that the average person invests in," he says. But electronic trading is helping to bridge that gap: Daily trading between banks and nonfinancial customers increased to 14%, or $266 billion, of the daily market, the BIS reported. That number includes companies as well as individuals.

Refco last year created a separate division for individual traders, and its retail accounts now trade as much as $15 billion a month, Mr. Fondren says. Gain Capital, a leading electronic-trading company that runs the investor portal Forex.com, says about half of $45 billion in "forex" volume comes from retail investors. Individuals account for 80% of its customer base, it says.

Last week, a Barron's magazine column featured Hotpsot FXi, which created a downloadable trading platform to help centralize the fragmented spot-currency market. The platform is meant for institutional investors, but individuals can take part using the RealTick platform, published by Townsend Analytics.

While the Merrill Lynches and Morgan Stanleys are mostly holding off on offering foreign-exchange trading until there is more demand from individuals, interest is growing. Charles Schwab & Co. recently formed a partnership with Refco to offer its customers the opportunity to trade currencies.

Gateway to the Masses

In 2001, the Chicago Mercantile Exchange launched a 24-hour electronic platform for currency contracts. Volume in the futures market has doubled in each of the last three years, averaging 115,000 contracts and $55 billion a day in 2004, Rick Sears, the CME's managing director of foreign exchange, says. He estimates retail investors' share of futures trading at about 15% daily.

If the average person's path to currency trading was made clearer by the CME, then CLS Bank International paved the road. The international bank in 2002 created what became known as the "gateway to forex" for the masses -- Continuous Linked Settlement, a network supported by 69 global banks and financial institutions that simultaneously matches buy and sell orders.

"CLS turned the FX market into the same as what we have in equities and bonds," says Nigel Renton, managing director of eSpeed Inc., the electronic trading unit of Cantor Fitzgerald Securities and an early participator in CLS. CLS matches orders in 11 currencies almost immediately by tapping into local networks of central banks as their hours overlap across time zones. It's "the biggest thing to happen in foreign exchange in 300 years," Mr. Renton says.

That may sound breathless, but dealers say digitizing the foreign-exchange market has made it as easy to trade currencies as stocks. Investors can open up an account with an online trading service, usually for free. Real-time rates are quoted in a bid-ask price -- just like stocks -- and traders make their money on the fluctuations in the constantly moving exchange rates.

As CLS streamlined back-office operations, electronic platforms proliferated, attracting customers with real-time data, charts and wireless connections. Some online platforms offer commission-free trades, which give smaller investors a chance to capitalize on the tiniest spreads through rapid-fire trades.

Foreign-exchange trading is even more nuanced than stock trading, says Mr. Fondren. A small political or economic development barely registering a blip in the equities market could have a major impact on currencies. The price fluctuations can get volatile, and that is where currency investors make their money. "If everything is flat ... that's pretty boring for investors," says Jonathan Butterfield, executive vice president of marketing and communications at CLS. The daily amount of cash traded in the spot market can vary by 30% on a day-to-day basis, he says.

Looking for a Black Box

The road to higher returns, though, is riddled with potholes. The hours can be grueling and traders can be overwhelmed trying to decipher what is moving a currency. "So much information is pumped out on a daily basis ... but that's what separates good traders from bad traders," says Mark Galant, chief executive and founder of Gain Capital, the online currency-trading platform.

While many of the "day-trading" type were shaken out with the dot-com bubble, some still plunge into foreign-exchange trading without understanding the market. "Everyone wants a black box system" -- a standard formula that wins every time, says Mr. Sullivan. They make a bet expecting the market to move incrementally, "but you can have a 40-point move in a matter of seconds on a press release," he says. It's like showing up at a Nascar race with a go-cart.

Steve Retz, 24, has learned such hard lessons. The first time he traded in currencies, "I thought it was easy money," he says. "There's quite a bit of expectation and I blew $15,000 or $20,000."

Mr. Retz, who designs computers and electronics for a living in American Fork, Utah, has been trading currencies for about a year. He likens himself to a money merchant, and figures he could live off the profit of several successful trades a day. But for Mr. Retz, who is married, trading is as much a hobby as 100-mile bike excursions. The novelties of both have worn off, but they are enjoyable with more subdued attention.

Traders have to subdue their emotions, regardless of intentions. "You have to really come to terms with ... the fear of losing money," says Mr. Retz. "How much are you willing to risk? Because the thing that gets people out of the market is that they let their emotions control them." But the emotional high is why many traders get in. His advice: Just don't bet your rent.