It is a confidence game played in the context of the foreign exchange market against fairly unsophisticated “retail speculators.” The U.S. Commodity Futures Trading

What are Forex Scams all about?

Commission (CFTC) which loosely regulates the foreign exchange market in the United States, has noted an increase in the number of these scams recently. Complaints cited by the CFTC since the beginning of 2004 revolve around managed accounts, false advertising outright fraud, and manipulation. CNN quotes an official of the National Futures Association as saying “Retail forex trading has increased dramatically over the past few years. Unfortunately, the amount of forex fraud has also increased dramatically.” Between 2001-2006 the U.S. Commodity Futures Trading Commission has prosecuted more than 80 cases involving the defrauding of more than 23,000 customers who lost $300 million mostly in managed accounts. CNN also quoted Godfried De Vidts, President of the Financial Markets Association, a European body, as saying “Banks have a duty to protect their customers and they should make sure customers understand what they are doing. Now if people go online, on non-bank portals, how is this control being done?” The highly technical nature of forex scams, the OTC nature of the market, and, the fact that foreign exchange trading is fairly unregulated, also makes exchange rate manipulation or price spiking easy for scammers to commence. Because of the technical factors mentioned above, the traders on the other side of the trade, or even regulatory authorities, will have an almost impossible task in proving that such manipulation has taken place. Partly because there is no central currency market, but rather a number of more or less interconnected marketplaces, provided by brokers and market makers. The foreign exchange market is a zero sum game in which there are many experienced well-capitalized professional traders (e.g. working for banks) who can devote their attentions full time to trading. An inexperienced retail trader will have a significant information disadvantage compared to these traders. Retail speculators are almost always undercapitalized, so are subject to the problem of Gambler’s Ruin. In a fair game (one with no information advantages) between two players that continues until one trader goes bankrupt, the player with the lower amount of capital has a higher probability of going bankrupt first. According to the theory, any speculator who plays this strategy is effectively playing against the market as a whole which has nearly infinite capital and he will almost certainly go bankrupt. Any speculator – particularly undercapitalized traders who do not have any informational advantages – should understand why his trading strategy is superior to the above strategy. The retail trader always pays the bid/ask spread which makes his odds of winning less than those of a fair game. Additional costs may include margin interest, or if a spot position is kept open for more than one day the trade must be “resettled” each day, each time costing the full bid/ask spread. Forex scammers, posing as customer brokers, use the standard confidence game techniques perfected in bucket shops and boiler rooms. The spot currency trades placed by retail speculators are made directly with the trader’s own “broker,” that is, the broker takes the other side of the transaction. Thus, many of spot trades never enter the open market and are subject to reorders which are issued to protect the profit margin dealing desk brokers impute in their fixed spreads or to “hedge” unbalanced trades. By offering high leverage, the broker may encourage traders to trade extremely large positions. This increases the trading volume cleared by the broker and increases his profits, but increases the risk that the trader will receive a margin call. While professional currency dealers (banks, hedge funds) never use more than 10:1 leverage, retail clients are offered leverage up to 400:1.