On January 15th, 2015, the Swiss National Bank eliminated it’s cap on the Swiss Franc in regards to the Euro. What does that mean? Well, up until that day, the SNB had said that the value of a Franc would be tied to the value of a Euro. Under that policy, they had maintained the Franc at a value of 1.20 Francs to 1 Euro.
Disclaimer: This post is being sponsored by ETX Capital. The content is mine, however, and isn’t influenced by their sponsorship.
Artificial Currency Valuation
In other words, they were artificially changing the value of their currency. And when they stopped artificially changing the value of their currency? The market corrected, and the Franc rose to a more reasonable exchange rate. At the same time, the Euro dropped. The big problem with all of that? There was no warning that it was going to happen. And as we all know from the housing crash in 2008, when there’s no warning, bad things can happen. Banks across Europe immediately felt the pressure. Within a day, it wasn’t just banks. It reached all the way down to many small investors around the globe. Most of those investors were FOREX investors. You see, FOREX investors invest in foreign currency with the expectation that the currency will increase in value. For years, the Franc was artificially stuck in one place. And then it wasn’t.
SNB Change Cost Many FOREX Traders
Many FOREX traders trade on margin, or leveraged investments. They’re required to keep a certain percentage of their overall investment in a cash account. Say $200 on a $10,000 investment. And when that $10,000 investment tanks and is suddenly worth only say, $1000? It’s not like they just get to walk away from that. They still owe the $9,000 they lost to the brokerage. But, just like in the housing crash, where many of the investing houses were over-leveraged on sub-prime mortgages, many of the investors simply didn’t have the cash to make up the difference. And many of the FOREX brokerages were left holding the bag, which left many of them in the same situation as the banks in the housing crash. Suddenly without much in the way of liquid funds and headed for bankruptcy.
Much like the housing crash, there were a few brokerages that had been cautious with their leveraging, and actually managed to escape relatively well from the SNB issue. One such brokerage was ETX Capital in London. Not only did they come through the fray, but, according to LeapRate, they’re buying up some of the brokerages that didn’t make it through so cleanly.
Limited Leverage and Risk Aversion Saves the Day
So, how did ETX Capital make it through the SNB fiasco? According to a LeapRate interview with the CEO of ETX, it’s because they’re a more risk-averse brokerage. In other words, they put additional limits on the leveraged investing of their users. That risk-averse, limited leveraging, allowed them to take far smaller hits in the markets and recover much more quickly.
What can we learn from ETX? Some risk might be good for us, but we have to be really careful about how much risk and leverage we have.
Limiting Leveraged Risk is Good for Personal Finance Too
Let me put it this way. How many of you reading this have less than $1000 in the bank right now, and over $100,000 in mortgage, student loan, and credit card debt? That’s leveraging. Your credit score is a numerical indicator of the likely hood that you will repay a debt. The higher the credit score, the higher the likely hood that you’ll repay the debt. When you take on a mortgage, or use a credit card, you are leveraging your credit score (and future income) for that “investment” debt. (*note: Debt is never really an investment. Don’t treat it as such, please.)
Why do we leverage our credit and income for debt? Because very few of us will ever have the patience or will power to save up for years so that we can pay for a house with cash. Most of us can’t make it a year to save up for a good used car. So, we leverage ourselves out to buy the things we can’t buy with cash. The more debt we accumulate, the more leverage, and thus risk, we have.
What happened to people who bought houses with those sub-prime mortgages before the crash? We all know the answer. We saw it streaming across our televisions and the headlines of our newspapers for over a year. They were foreclosed on. The economy dipped so hard that there was serious discussion about it becoming another “Great Depression”. And those people lost their homes.
What if we were more like ETX Capital and other brokerages and banks that self-limit their leveraged risk?