Retail FX might go down, but it's not out

While the US reviews tighter regulations on companies offering retail FX services, some analysts are saying that, if the yen cleanly breaks 100, there could be panic from retail investors in Japan who invested through futures in high yielders. This could lead to default from specialised online futures brokers.

This conclusion might be a bit hasty, given that the past few months of volatility haven't quite resulted in the collapse of any retail trading shops - in any significant fashion anyway. During the spark of volatility in August last year many were probably burned, but volumes haven't thinned.

On August 16, for example, online trading company FXCM's Speculative Sentiment Index found open positions in the yen were down 15% overnight. Meanwhile, banks had been reporting Japanese retail FX traders had reduced their positions by more than 80%. This, said Kathy Lien, chief strategist at FXCM in New York, at the time suggested "Mrs Watanabe" was getting "shaken out" by the moves. This included GBP/JPY falling 700 points from its high that day and 1,200 points since the beginning of that week. But they came back.

The good fortune that FX markets have is liquidity. With an average daily turnover of $3.2 trillion, FX is the largest asset class out there and boasts decent electronic liquidity on established platforms even during volatile times.

Talking to one online trading company, it became clear that establishing a strategy to target the retail FX market as a wholesale bank makes total sense. What makes less sense is extending online retail distribution strategies into products such as metals. This might explain why there are some rumblings about Deutsche Bank re-considering plans to extend its online flow retail products business beyond FX.

The risks associated with extending into less-liquid products are simply too high. Consider the $141.5 million loss made at MF Global by a single trader. Apparently, the trader had only been able to carry out the unauthorised trade because of the recent growth in the wheat futures market. "Wheat has become much more liquid in the past 14 days, which is why he could put on positions large enough to lose so much money at one time. We are seeing moves in a day that we would have expected to see in a month," said MF Global's chief executive Kevin Davis.