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What happened on Black Thursday

 

Black ThursdayA normal employee in the private sector always fears of a Black Friday. Normally Friday is the day when companies release bad news, which quite often coincides with firing employees or making redundancies. In the Forex market it happened on Thursday. The most well-known Forex brokers with the strongest books ended up losing millions within an hour; even stock listed companies were severely affected.

On Thursday January 15th 2015 the Swiss National Bank issued a statement that it would scrap the EURCHF floor it said it would continue to support. In a surprise announcement the foreign exchange currency market experienced the largest major currency move that has been seen in modern times. Since nearly all currency traders never expected such movements most traders with open positions that were related were either in for huge gains or their accounts being wiped out and often going into negative figures.

We remain surprised that the biggest Forex brokers were affected on such a large scale and we noticed that generally medium to small brokers managed to pass through this crisis unscathed.

The CEO of FXCM gave a clear account on what happened that day with their clients’ accounts. Considerably high net worth traders or investment firms were relying on the fact that there was an artificial floor on the EURCHF and that no matter what happened it should always remain above a certain level. Therefore many serious and institutional traders held long positions on this currency pair; it was simply a sure thing. On that date FXCM was considered one of the most established and reliable brokers that held prime broker agreements with banks. So they kept their large exposure covered with the banking sector in the case of movements that they were not capitalised enough the handle themselves.

Under normal and even highly volatile market conditions it is a wise move for brokers to cover exposure with third party liquidity providers and banks when there is a level of exposure they cannot handle. Unfortunately, on that specific date having positions covered through liquidity bridges simply did not work. The banks stopped providing prices for the CHF pairs and then when they eventually started offering prices the market has already moved 44 standard deviation. The exposure of the biggest brokers on those pairs was so big that their clients’ accounts showed a negative balance of millions. The accounts brokers held with their liquidity providers also shot into the red by huge number and the brokers were forced to cough up or declare bankruptcy. For some brokers raising the required capital to remain solvent could only happen by a cash injection from shareholders or by requesting clients cover the negative balances they had in their accounts.

It doesn’t take a genius to see that there were inevitable cases where shareholders didn’t have funds to save their companies or it didn’t make financial sense to do so. The collection of funds from client’s to cover their negative balances was also seen as futile as there were many cases of retail traders with a few thousand deposited that suddenly had six negative figures on their account. It was a given that large numbers of traders simply didn’t have the required funds or were unwilling to put their balance back in the black. On top of that the brokers didn’t have liquidity to wait for deposits from clients. For this reason many brokers simply wrote off negative debts if they could, or they declared bankruptcy.

The biggest casualties included the absolute gob smacking bankruptcy of Alpari UK as well as a swift cash injection for FXCM, which at first looked like another bankruptcy was on the cards.

This, of course, didn’t go without notice by Forex traders and clients of affected brokers who swiftly started looking to trade elsewhere. Surviving brokers that were affected from the movements on the SNB announcements also lost a large percentage of their client base to other brokers. Brokers that held their own introduced special promotions for clients that were looking for a new broker.

So what did we learn from Black Thursday? We learned that the back to back liquidity model of ECN or STP brokers didn’t work in an extreme market movement. However, if you were trading with a Market Maker that only used their own liquidity 100% then they as a broker would not have been affected but may not have had sufficient capital to pay out huge profits some clients could have made. In this specific case however most traders were long on the EURCHF so generally the market maker model worked here, lots of clients’ accounts got liquidated and those brokers made money.

The real consequence for traders was that they had to rethink about the brokers they have invested their money with and in many cases traders decide to diversify their portfolio across multiple brokers as much as they could. At that time a MM model clearly worked better for your money but what is ideal in the long run? As a trader you should look what the maximum amount of protection your broker can offer and spread your funds across different brokers, below the protection thresholds. The UK’s regulator protects clients’ deposits up to £50,000 GBP and most other European brokers provide €20,000 worth of protection. If you have an amount over this figure then you will need to spread it around multiple brokers and there are no limitations on the number of brokers you can have accounts with. The ultimate lesson we learned from Black Thursday is that “Too Big to Fail” does not always work in the Forex market.

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