Forex Trading Scams

A forex scam is a confidence game played in the context of the foreign exchange market by "customer brokers" against fairly unsophisticated, under-capitalized "retail speculators". The U.S. Commodity Futures Trading Commission which loosely regulates the foreign exchange market in the United States, has noted an increase in the number of these scams recently.

In the language of con men, the retail speculator is known as the "mark."

Why Retail Speculators Shouldn't Be Able To Beat The Market

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 traders are - almost by definition - undercapitalized. Thus they 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. Since the retail speculator is effectively playing against the market as a whole - which has nearly infinite capital - he will almost certainly go bankrupt.

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.

Why Retail Speculators Can't Beat The Market

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, most of these spot trades never enter the open market and are subject to the broker's price manipulation. The broker will almost inevitably take all of the mark's investment.

The Marks Suffer From At Least 5 Fatal Disadvantages:

The marks have no competitive prices to trade against, i.e. they must accept their broker's price or not trade.

The broker may show them actual prices from the forex market, but only with several minutes delay. Thus the broker has better information to trade on.

The marks are encouraged to over-leverage their trades, thus almost insuring that the will "receive a margin call" allowing the broker to close any open trade immediately, at the broker's price.

The brokers work as a team of several people as the forex market trades 24 hours a day. An individual trader will not be able to monitor his trades (and his broker's actions) for 24 hours a day.

The marks look to the brokers for training in the foreign exchange market and may actually buy their trading advice.

By offering high leverage, the broker makes it possible for the retail trader to buy or sell more than his equity allows. In reality, this practice fuels the greed of many traders, who buy or sell too large sums in the market. But at the same time, this increases the trading volume cleared by the broker. And as the broker gets his compensation from the spread, larger trades leads to bigger spread revenue. Also, the traders usage of high leverage enhances the risk, that the trader will receive a margin call if the market moves against him.

While professional currency dealers (banks, hedge funds) never use more than 5:1 leverage, retail clients are offered leverage up to 400:1.

Typically the mark will have a profitable first trade (as manipulated by the broker) in order to increase his confidence in the broker and encourage the mark to "invest" more money. Next, the mark will receive a margin call, telling him that he must deposit more money or his trades will be closed out. The scammers will do anything to get the mark's money deposited with them, since eventually all this money becomes theirs.

Traders will be encouraged to trade on margin and set stop loss orders, which allow the broker to close out the trade almost at will during busy markets at prices set by the broker.

Trade prices are easily skewed one way or the other, depending on the retail trader's position, which is known by the broker. Marks can be encouraged to take risky positions just before major economic announcements. If all else fails, the broker can quote extreme prices (known as spiking) to trigger stop loss orders while the mark is at work or asleep.

In any case, all of the mark's money will be transferred to the scammers without any trade being made in the open market, and without any economic risk being created or destroyed.