Retail Brokers May Take Away 10% of Account Equity Every Month

The two most overlooked parameters when choosing a fx broker are rollover and foreign exchange costs. Many are not even aware of them, even if such costs may be equal 2-3 or even 10% of account equity per month.

Usually a potential client looks at spreads, user interface and technology to choose an account. There are other things to consider and those are so important that can easily be a deal-breaker.

Rollover cost is one of such. And such rollover cost may not be obvious until one starts to trade. You receive interest for long currency positions in your account and pay interest for short currency positions. Say, if interest rate for Australian dollar is 5%, you should collect this interest on you long positions and pay interest at the same rate for short positions. In practice, those rates are set by the broker and, in a typical case, you are likely to receive 3% and pay 7% rather than 5% both ways. It is systematic to abuse interest rate setting and a real life example is that clients pay as high as 30% rollover cost. In other words – if you have a short position over a 12 month period and the currency duly declines 30%, you make nothing, just because your profit is taken away as rollover cost, if taxed at rate of 30% p.a.

Another issue is foreign exchange cost (for any type brokerage account, not only FX). If there is a clause in the account agreement that all P/L is converted to account base currency at the end of the day, all you P/L balance in foreign currency will be converted to base currency at close of business day at bid price and bought back at ask price at the beginning of the next business day. Such bid-ask spread may be as wide as 0.5% and your P/L will be continuously taxed at this rate daily. Say, if the account base currency is EUR, but half of the account equity consist of profits denominated in GBP – half of the account equity will be taxed through currency conversions – even if no trades are placed in the account, account equity can decline by as much as 8-9% per month as a result of foreign exchange cost as imposed by brokers.

Those are very unfavorable odds to trade against – as much as 10-11% of account equity per month may accrue as imposed transaction costs. Thread carefully and better avoid retail brokers.

Currensee: premium fee for basic service

 Currensee allows investors to mirror trade real trading accounts of traders. As a part of service, they do due diligence on traders before they approve them as eligible for investor accounts (and brand such traders as trade leaders). This is a big difference from other services like Collective2 and Zulutrade which are open to all traders. But then, the choise of which traders to select is up to the investor himself. Regulatory and corporate liability considerations should play a role here. They charge a hedge fund like fee of 2/20 fee (2% management fee and 20% incentive fee). Given the fact that investor selects the traders himself, this is a high fee for the service (additionally, Currensee receives rebates from broker).

Currensee pays the traders 15% of the profits they make for investors, but no share of management fee or broker rebates. This is a near-optimal arrangement as the investor interests are aligned with those of traders and there is no incentive for churning. And this is a one of the best deals out there for traders.

Currensee, now owned by retail forex company Oanda, is one of the safest ways to start copy trading, but it is heavy in terms of fees and for anybody with basic skills in trading algorithm evaluation it is more beneficial to look elsewhere. The reported average return of 11.94% p.a. (as on Sep 30, 2013), not adjusted for fees, is less than impressive for this type of investing.

Beyond PIMCO Analysis of What If? There is a Strike on Iran Nuclear Facilities

This question pops up in my mind every day for the last few weeks. What impact this will have on foreign exchange rates, if there is a strike on Iran nuclear facilities. Will it be like every time before with USD and CHF stengthening on safe haven buying? Or will this time be different and USD will weaken? Or will USD strenghen in line with a historic pattern initially and then plummet? PIMCO has given their opinion about the impact of such strike on oil prices, but it says nothing about currencies.

The argument for weaker USD may be that any such strike is, effectively, imposible without US support. Meanwhile, once unbeatable technological supremacy of US (and other developed nations) is slowly fading away. There are countries with highly uncertain, by Western standards at least, way of thinking in disposition of nuclear weapons. India, Pakistan have some, probably Iran, North Corea has some (let’s hope Kim has enough submissive girls around him so he does not feel and urge to prove his manhood with nukes). It is highly likely that certain groups (aka terrorist groups) have them and, if not, certainly can obtain them in various ways with sufficient financial backing they have. And they have a way to take the material onshore US (if no other way, then the same way as large shipments of drugs are taken into US — remember Kevlar-covered submarines confiscated from Colombian drug cartels).

All this is bad for, first of all US. The risk is there more than anytime before and US is one of the first targets. Unfortunately, system trading can’t handle such black swan events,  like attack on Iran, well. System trading is the most succesful when there are repetitive patterns in the price action; it is the least useful when there is once in a lifetime event like a major attack of any kind.

However, my bet is that, if such attack takes place, the USD strength, if any, will be short-lived and safe haven buying will be directed mostly to Swiss frank, Norweginan kronor and probably AUD and NZD.
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Boston Technologies Offers Your Own FX Brokerage for $48´000

Foreign exchange is the world´s biggest market with nearly $ 4 billion daily turnover.  Almost anybody, subject to background check, can open his/her own FX brokerage for $50´000 or so.

Boston Technologies, as a technology partner, offers to get you up and running in 3 months for $ 48´000 upfront fee and $ 3´000 monthly maintenance fee (no charge for the first 3 months).

The technology is top-notch, uses MT4 and MT5 user terminals. In some jurisdictions, like Seychelles, there are no licencing or capitalization requirements for forex brokers.

Good offer, if you´ve got non-US clients.

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Still investing in stocks? AlphaClone may be for you

I´ve mentioned AlphaClone before as one of the most interesting service providers in system trading. They track some of the best performing money managers, exploiting the legal requirement to report key positions and public availability of such information.

Although only U.S. based money managers can be tracked this way, one gets access to information where some of the best stock investors place the money. Imagine some of the most brilliant minds evaluating information for the purpose of making money through stock investments. Imagine top budget resources ploughed into investment research. And then … imagine the results disclosed to you at no cost.

Basically, this is what AlphaClone is about. http://blog.alphaclone.com/

Capital Traders Group and Apiary Fund: False Proprietary Trading Company Claims

We have moved the blog here.

I look for information on companies allocating capital to independent traders.  I´ve my own opinion that allocation of capital to multiple independent traders is the most intelligent investment approach for foreseeable future.

Unfortunately, by far most of the firms claiming allocation of proprietary capital is doing anything but that. Usually such allocation claim is just a smoke screen for another service – like training course or day-trading brokerage account.

Two examples are Capital Traders Group and Apiary Fund.

Capital Traders Group claims to allocate proprietary capital for individual trader to trade. When one reads through the small print, basically the offer is to pay $2500 fee and trade $25000 of ¨proprietary capital¨ and keep 99% of profits.  The trading is stopped, if the ¨fee¨paid does not cover incurred losses sufficiently. Obviously, the service is most suitable for persons who want to day-trade stocks, but do not have USD 25´000 to open day-trading  account. Probably, the terms are different for experienced traders with track record, but the standard terms suggest there is no genuine allocation of capital to independent traders.

Apiary Fund delivers a smooth sales pitch for the crowdsourcing the trading performance. It is only late in the presentation when the sales pitch switches to promoting the training and trading platform they provide and disclosure that they charge $695 enrollment fee and $97 monthly technology fee. There no mention of the amount of captital they have in the fund and there is little justification for the fees other than that Affinity Trading Group charges $4995 for 7 day trading and SMB Training charges $6000 for 4 month training. The very fact of comparing themselves to training companies implies that Apiary Fund promoters consider training fees rather than profits from trading proprietary capital as the primary source of income. The low capital allocation (as low as $1000) at entry level just confirms the same.

My vision is that genuine proprietary trading company should not charge any obligatory fees to prospective system traders, but use adequate process of evaluation of the trading systems on risk/reward basis. If the trader and his system passes the evaluation test, the trader should receive competitive remuneration from proprietary trading company rather than pay to it.

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What Exactly Is Trend-following?

Some suggest that trend-following is the only investment style any thinking man should ever use. As opposed to all other investment styles. But what exactly is trend? Seems an easy task to define trend as a general direction in which any particular price tends to move.

Yet, when to apply time frame to price series, then the term gets more obscure. Day trader is just someone who trades intra-day trends. And a scalper is just another trend-follower who trades very short-term trends lasting minutes, if not seconds.

I once asked to Ed Seykota, a well-known apologete of trend-following, on his blog, if he considers trend-following as the only valid approach to markets. His answer was that all profitable systems trade trends; the difference in price necessary to create the profit implies a trend. However, he expands it a bit further. Full article available here (scroll down to Trend as a Law of Nature?).

I personally think that the term trend-following is more a notion than an investment style. Basically, the only important trend is the performance trend of any particular investment strategy.  If performance, on risk-adjusted basis, is good, one shouldn´t care if the underlying strategy is trend-following or not.

Fukushima and System Trading Performance

How system trending works when encountered with black swan events like the recent Japanese earthquake? The short answer is ¨Bad!¨

The backbone of the system trading is finding repetitive patterns in the price behaviour and trade those patterns. As such, system-trading is not suited to profit from low probability events [aka black swan events]. By definition, black swan events have no repetitive pattern and happen so rarely that no system can be designed to capture the price movement.

Some factual information on this can be found in a recent Financial Times article.

What´s worse, black swan events almost certainly ruin system performance for unknown period of time until the price behaviour returns no casual, ¨normal¨ repetitive pattern which is critical to derive profits from system trading.

The system trading portfolio can be protected from excessively negative effects of black swan event through diversification and preset stop-loss level.

Diversification may help. I call it diversification with no limits in the fund brochure. Diversification over asset classes, geografical regions, traders, timeframes, trading styles. Diversification doesn´t remove the risk per se. But it reduces substantially the probability of massive drawdown. Even in our connected world it is highly unlikely that everything goes wrong everywhere and, even it does, the some systems in the portfolio will be negatively correlated and so contribute to a more stable portfolio performance.

Preset stop-loss level may help as well. The obvious ones are stop-loss levels for each system and the portfolio as such, but also per day, per asset class etc. Once black swan event unfolds and the portfolio value fluctuates out of ordinary levels (be it negative or positive), it makes sense to suspend trading until the fluctuations return to their usual repetitive pattern [so instrumental in process of extracting profits from the market via system trading].

 

Attain Capital Management

For investors embracing system trading as an investment style Attain Capital Management may be of interest. As well, they have no-nonsense research and a blog. I´ve no first-hand experience with them and would like to hear from someone who has.

Trading forex on fundamental data

Is it possible to trade on fundamental data? Some are highly sceptical about it, call it funny-mentals … The key problem seem to be timing the entry and measuring stoploss levels. Fundamentals may tell that the financial instrument is ¨cheap¨ or ¨undervalued¨, but it tells nothing about entry points. The fact that something is cheap doesn´t mean that it can´t get even cheaper. If somebody buys something based on fundamental analysis and the price goes down, the lower price makes the buy argument stronger while the account carries unrealised loss.

Common wisdom tells that trading forex on fundamental data is almost impossible. Too many factors at play, some of those hardly measurable – the noise is likely to be too overwhelming and the probability of mistake so high that any findings are rendered useless.

Nevertherless, we find one simple fundamental model fairly reliable predictor of exchange rate. The model analyses the interaction of several fundamental factors such as GDP growth, inflation, money supply to project exchange rate direction. The rationale is that, although the exchange rates may divert from the fundaments to a great extent, sooner or later the exchange rates will correct to reflect the fundaments of the underlying economies.

This particular fundamental model has been noticably precise. It needs some non-fundamental, technical input to identify entries and exits, but it is a great tool to improve the odds of long-term trend-following trade being profitable.

Attached here is a reseach summary back in Y2008 calling for ¨doomed GBP¨. The chatter was positive for the cable at the time and there was little to suggest a sharp downtrend in GBP. The rest is history.

Empirical evidence suggests that this fundamental analysis model can be applied to predict long-term currency moves. Yet, conventional technical analysis is required to identify entry and exit price levels.