
Trading a Real Market: What the Swiss National Bank Taught Retail Traders - ca98am79
http://mechanicalforex.com/2015/01/trading-a-real-market-what-the-swiss-national-bank-taught-retail-traders-today.html
======
vegabook
What the SNB really taught people this week is what emerging markets people
have known for decades, and actually, developed markets traders really should
know too. You should never trade a peg in the direction that is being defended
by a central bank. You should almost always _fight_ the central bank.

Anybody who takes a cursory glance at history will know this: ERM 1992, Russia
1998, Brazil 2001, and yes, Russia H2 2014 (semi peg). The examples of peg
breaks are numerous, and some recent. No excuses.

A "grid trading" strategy that was essentially recommending picking up pennies
in front of a steamroller, was irresponsible at best. One should always look
at the balance of payments of a country to see if it is in surplus or deficit,
and trade the currency accordingly. Swiss was in massive surplus on the
capital account. This guy was recommending selling swiss francs for a tiny,
marginal carry trade in euros.

And if you don't know what balance of payments means, you really should figure
it out before committing money to the FX market.

Finally, all the bull about liquidity. Of course there is no liquidity when a
market revalues suddenly. This is the same in equities: if an unexpected
announcement happens, the price revalues instantly and there is no liquidity
in between. It is a discrete event. Econ 101.

~~~
gus_massa
[Hi from Argentina!]

I agree, but usually the pegs in the other direction are more dangerous.

When the government has too many Dollars (or Euros) they usually have time to
find a soft solution and change the conversion rate slowly. It's always easy
to burn money.

When the government has too few Dollar (or Euros) the amount of reserved money
go down, they exchange the real money for valueless internal bonds, and one
day they get up and they don't have any money left in the treasure and they
are forced to make an abrupt correction.

So this suddenly change is strange. YMMV.

~~~
vegabook
Good point, and China has for years adopted this approach. Problem is, they
are now long of a trillion dollars of US debt, and are as a result, at the
mercy of their own debtor. I think the Swiss were wary of that scenario:
becoming longer of European debt. If they had adopted a gradual approach, they
would have been showing their spoof poker hand, days after having asserted
that the peg wouldn't move. The market would have sold billions more euros to
them which they didn't want.

------
minimax
There is a good section about currency bands in Nassim Taleb's first book,
Dynamic Hedging. It's a fairly technical book about risk management for
options traders, but the section on Market Barriers is particularly germane.

I think it's valuable in the sense that it gives you a window into the way a
skilled risk manager views the world versus the naïveté of retail traders.
This was only a "black swan" event if you had no idea what you were doing.

[https://books.google.com/books?id=-5-OldaTjVQC&lpg=PA227&ots...](https://books.google.com/books?id=-5-OldaTjVQC&lpg=PA227&ots=L_7HVjyaVk&dq=options%20wizard%3A%20and%20ems%20war%20story&pg=PA224#v=onepage&q&f=false)

~~~
onewaystreet
His advice is all well and good but "skilled risk managers" can be just as
dumb as everyone else. This has been proved multiple times in just the last
few decades alone.

~~~
300bps
_His advice is all well and good but "skilled risk managers" can be just as
dumb as everyone else._

I work at an investment bank and I can safely confirm that most professional
investment managers and risk managers fall for this type of stuff all the
time.

If you want an example, look as Nassim Taleb's idiotic moves. Here's just one
from 2010:

[http://www.moneynews.com/StreetTalk/Nassim-Taleb-Shorting-
Tr...](http://www.moneynews.com/StreetTalk/Nassim-Taleb-Shorting-
Treasuries/2010/02/04/id/348993/)

So in 2010 Taleb's advice to short U.S. Treasurys. How'd he do in the last 5
years? If he followed his own advice then he lost almost half his money on
that trade as US Treasury rates fell dramatically since then.

I'm not picking on Nassim Taleb. He's a smart dude. But everybody - everybody
- makes dumb investment decisions.

~~~
minimax
Shorting treasuries in 2010 was a popular sentiment. I'm sure you could have
found a similar suggestion in the WSJ at the time. It is extremely unlikely,
given Taleb's background as an options market maker, that he would have
expressed that trade simply as an unhedged position in cash treasuries or the
futures while he sat bleeding money for five years straight. It's an important
distinction to make and I think it comes back to my original point about risk
management. It is one thing to make a prediction and it's a separate step to
then formulate a trade that captures upside if your prediction is correct and
limits your downside if your prediction is incorrect. From a trader like
Taleb, I think that's implicit in his statement, but maybe it wouldn't be so
obvious to a layperson.

~~~
conistonwater
Taleb was very precise in what he said, and he didn't say anything like what
you are attributing to him. There wasn't any real nuance, he really just said
it was a good idea to short treasuries:

[http://www.bloomberg.com/apps/news?pid=newsarchive&sid=azLmk...](http://www.bloomberg.com/apps/news?pid=newsarchive&sid=azLmks3BmQm4)

[http://noahpinionblog.blogspot.ca/2014/01/of-brains-and-
ball...](http://noahpinionblog.blogspot.ca/2014/01/of-brains-and-balls-nassim-
talebs-macro.html)

~~~
minimax
Taleb has written literally hundreds of pages on risk management and if you
don't consider any of that as context, I guess you could assume he literally
meant to get short some delta one treasury product. I think that's a little
bit naive but whatever.

You can watch the full video here:
[http://2010.therussiaforum.com/news/session-
video3/](http://2010.therussiaforum.com/news/session-video3/)

You have to switch it from Russian (ру́с) to English. He says you want an
"active position" where you "benefit from rise [in rates]." The video then
shows Hugh Hendry, who has basically the opposite position but for European
government bonds. He is short rates (so long bonds) _but he has an options
position which fixes his maximum loss at some known value._ Hendry spells it
out, but I think given Taleb's background, he probably meant something like
that (but in reverse).

~~~
conistonwater
Okay, I watched a bit of the video now (thanks for linking to it). I still
don't see what's so ambiguous about "stay short Treasury bonds", he says it
quite directly, and as far as I can tell from the video he means it, but maybe
I'm wrong. He also says in that video says you should buy deep out of money
options on gold/other metals in case hyperinflation happens.

So first, as far as I can tell, he really did say and mean those things.

Second, the suggestions, the bet on rising interest rates, as well as the bet
on hyperinflation, are, I think, ignoring basic macroeconomics, and they
pretend that some really implausible outcomes can happen. Maybe you would
hedge the bet, and have other trades that bound your losses, but they would
still have lost money. I don't think it matters _that_ much that with a
cleverer execution they would have lost less money. The point is that they
were wrong in the first place.

~~~
Tycho
You talk about basic macroeconomics, the way someone might talk about 'basic
finance.' I think that's the whole problem...

------
PhantomGremlin
Not everyone was surprised by the SNB's action. I haven't seen the following
discussion reported widely. I only have a link to a video, no transcript. But
it's short, little over 1 min in length.

Some smart money started moving into CHF last month. More interestingly, there
was a lot of movement about one minute ahead of the announcement.

[http://finance.yahoo.com/video/traders-knew-snb-move-
pro-060...](http://finance.yahoo.com/video/traders-knew-snb-move-
pro-060000457.html)

Here's the ending:

    
    
       Announcer: despite everything we've heard about
       manipulation of foreign exchange markets, about
       the deep forensic look into these markets,
       you're saying there was action before the
       announcement which indicates there was some
       parties in the market that knew this. I want to
       be categorical about this.
    
       Guest: It definitely looks like that to us.
       There was a movement in the market well ahead
       of the headlines, and a huge flow throughout
       December, an unprecedented flow, in the leadup
       to yesterday's break of the peg.

------
marcusgarvey
It was bad form for the SNB to say they were committed to the peg and then to
scrap it a few days later. On the other hand it shows how entitled markets
have become to having central banks telegraph their strategy to the world.
Would monetary policy & markets ultimately work better if we didn't expect
central banks to be so blatant about their future moves? At the very least it
would shake out the dangerous complacency that leads to overcrowded trades &
heightened contagion risk.

~~~
paganel
> It was bad form for the SNB to say they were committed to the peg and then
> to scrap it a few days later.

I may be wrong, but I think the decision to get rid of the cap was ultimately
the result of an ECJ's judge statement made the previous day:
[http://www.telegraph.co.uk/finance/economics/11344253/ECJ-
ru...](http://www.telegraph.co.uk/finance/economics/11344253/ECJ-ruling-paves-
way-for-eurozone-QE.html) , so not much that SNB could do about it.

~~~
conistonwater
But that decision was about ECB's QE, I don't think this is as clear as you
make it sound. SNB _could_ have chosen to continue the peg through any ECB
actions, but instead they chose to scrap it. It was still their decision,
although you can argue that they wouldn't have been successful had they
decided to continue the peg.

------
brianbreslin
So this is slightly deviating from topic, but still on it. Can someone explain
why forex has looked like shady stuff for so long and there are so many get
rich trading forex ads all over the web? I have never dug into this, so I am
just genuinely curious. How does that industry work?

~~~
justincormack
Pull people in, lose all their money via high leverage (stop them out when
they lose), repeat with new sucker. You have to get new customers to pillage
constantly, hence the advertising. Plus it is more or less unregulated
(leverage is limited to 50x in US, unregulated elsewhere). The companies dont
have to hedge the positions much, as many net out, and people will mainly be
losing money.

------
squozzer
Not a trader certainly not forex but the blood was in the water the day the
Swiss decided to peg. Certainly they had their reasons - to keep the franc
from becoming too strong - but as other commenters have already explained pegs
are too difficult to defend and in this case, the EU was nowhere near a
consensus on monetary policy. I like the "picking up pennies in front of a
steamroller" analogy it fits the situation perfectly.

------
AnInternetGuy
And that is why you make high-risk trades with options, or not at all.

------
comrade1
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?

~~~
ghshephard
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](http://www.investopedia.com/ask/answers/06/forexleverage.asp)
[2] [http://www.investopedia.com/articles/forex/08/margin-
leverag...](http://www.investopedia.com/articles/forex/08/margin-leverage-
forex.asp)

~~~
jayess
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.

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

~~~
waps
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.

~~~
cheatdeath
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...](http://www.bloomberg.com/news/2015-01-16/fxcm-faces-losses-on-
franc-trades-as-swiss-shock-spreads.html)

