Retail Traders – Beware Of These Trends
- Heightened Volatility: The surge in speculative activity, especially high-frequency trading dominated by computerized or algorithmic trading, may contribute to higher currency volatility, which increases the risk of runaway losses for the small investor or trader.
- Information Disadvantage: Retail investors are at a distinct disadvantage in the largely unregulated global forex market, since they do not have access to information about large commercial transactions and capital flows only available to the biggest players who dominate the market. This information asymmetry makes it difficult for the average retail investor to gain any type of advantage over professionals.
Retail Forex Regulation
Regulation Also Required For Institutional Investors
- Higher Hedging Costs: Increased currency volatility caused by excessive speculation leads to higher costs incurred by corporations and other commercial players for hedging currency risk.
- Systemic Importance of Big Banks: While forex trading losses were not prominent in the biggest trading losses posted by corporations and financial institutions to date, the potential does exist for billion-dollar losses on wrong currency bets. Although currency trading is a zero-sum game, a massive loss incurred by a big bank could have a ripple effect on the global economy due to its systemic importance.
- Undue Enrichment of a Few at the Expense of Millions: Exaggerated or unjustified currency moves can adversely affect a nation's economy. Although such moves may be justified by underlying economic fundamentals in some cases, in many other cases temporary weakness in a currency can be exploited ruthlessly by speculators, sending it into freefall in a self-fulfilling prophecy. This can trigger capital flight and a prolonged recession precipitated by sharply higher interest rates to defend the currency. This scenario has played out on several occasions over the past two decades; a notable instance being the collapse of the Thai baht in July 1997 and the subsequent Asian crisis. While currency speculators raked in the profits, millions of people in the affected nations suffered huge wealth erosion and long periods of unemployment.
The Bottom Line