A forex scam is any trading scheme used to defraud individual traders by convincing them that they can expect to gain an unreasonably high profit by trading in the foreign exchange market. "The average individual foreign-exchange-trading victim loses about $15,000, according to CFTC records" according to The Wall Street Journal. This market would be a zero-sum game were it not for the fact that there are brokerage commissions, which technically make forex a "negative-sum" game. "The market has long been plagued by swindlers preying on the gullible," according to the New York Times .
These scams might include churning of customer accounts for the purpose of generating commissions, selling software that is supposed to guide the customer to large profits, improperly managed "managed accounts", false advertising, Ponzi schemes and outright fraud. It also refers to any retail forex broker who indicates that trading foreign exchange is a low risk, high profit investment.
The U.S. Commodity Futures Trading Commission (CFTC), which loosely regulates the foreign exchange market in the United States, has noted an increase in the amount of unscrupulous activity in the non-bank foreign exchange industry.
An official of the National Futures Association was quoted as saying, "Retail forex trading has increased dramatically over the past few years. Unfortunately, the amount of forex fraud has also increased dramatically..." Between 2001 and 2006 the U.S. Commodity Futures Trading Commission has prosecuted more than 80 cases involving the defrauding of more than 23,000 customers who lost $350 million, mostly in managed accounts. CNN also quoted Godfried De Vidts, President of the Financial Markets Association, a European body, as saying, "Banks have a duty to protect their customers and they should make sure customers understand what they are doing. Now if people go online, on non-bank portals, how is this control being done?"
The highly technical nature of retail forex industry, the OTC nature of the market, and the loose regulation of the market, leaves retail speculators vulnerable. Defrauded traders and regulatory authorities can find it very difficult to prove that market manipulation has occurred since there is no central currency market, but rather a number of more or less interconnected marketplaces provided by interbank market makers.
Why retail speculators shouldn't be able to beat the market
The foreign exchange market is a zero sum game in which there are many experienced well-capitalized professional traders (e.g. working for banks) who can devote their attentions full time to trading. An inexperienced retail trader will have a significant information disadvantage compared to these traders.
Retail traders are - almost by definition - undercapitalized. Thus they are subject to the problem of Gambler's Ruin. In a fair game (one with no information advantages) between two players that continues until one trader goes bankrupt, the player with the lower amount of capital has a higher probability of going bankrupt first. Since the retail speculator is effectively playing against the market as a whole - which has nearly infinite capital - he will almost certainly go bankrupt.
The retail trader always pays the bid/ask spread which makes his odds of winning less than those of a fair game. Additional costs may include margin interest, or if a spot position is kept open for more than one day the trade must be "resettled" each day, each time costing the full bid/ask spread.
According to the Wall Street Journal (Currency Markets Draw Speculation, Fraud July 26, 2005) "Even people running the trading shops warn clients against trying to time the market. 'If 15% of day traders are profitable,' says Drew Niv, chief executive of FXCM, 'I'd be surprised.'
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