Picture this. You are a very good trader, trading mainly with technical indicators. You use such tools as charts, Bollinger Bands, support and resistance, slow stochastic, money flow and several other indicators. These skills have served you well and you have a successful 10 year track record. You like the leverage of trading commodities and currencies. Currencies offer the greatest leverage, requiring only a 2% margin. That means that you put only $2.00 down for every $100 you trade. You are rather conservative and even though you have a $10,000 account you trade only $2,000. With a $2,000 margin at 2% you are controlling $100,000 of currencies. You are trading $2000 of EUR/CHF. Currencies are always spread trades. In this case you are buying the Euro (EUR and selling the Swiss Franc (CHF).
You wake up on Thursday January 15, 2015 to check your account. The European markets are already trading and you find that the Euro is down by 18.77% against the Franc. You simply can’t believe this is true since the normal range for the past 12 months has only been 1.7% and less than 1% in the past three months. You call your broker and he says: “YES what you see is true. You have been wiped out. Keep in mind that the drop of 18.77% is against your $100,000, NOT YOUR $2,000 MARGIN. 18.77% of $100,000 is $18,770. You now owe the brokerage firm $8,770 ($18,770 minus $10,000).
Now take this to a higher level, to brokerage firms and banks. FXCM, one of the largest brokerage firms was negative $225 million and had to borrow $300 million at 10% from Leucadia to stay afloat. Their stock dropped 92% to 98 cents before rebounding to $4.44 after the loan. Deutsche Bank and Citi were both in the tank for $150 million
Why did this happen? In 2010 the economy of Europe was teetering on the brink so money poured into Switzerland as a safe haven. This started driving the Swiss Franc higher. The effect was to hurt Swiss exports. The Swiss government decided to PEG the Franc against the Euro at CHF 1.20 per Euro. This worked well until the Euro started falling below the 1.20 peg. The Swiss Central Bank was forced to buy billions of Euros and losing on their trades. They decided to throw in the towel and pull the peg on January 15, 2015, hence the chaos that followed.
What happens next? By pulling the peg on the Franc, we could see a further drop in the Euro. The timing of this move is also quite negative for the Euro. The European Central Bank (ECB) may start quantitative easing next week. This move by the Swiss one week before the start of easing may further weaken the Euro. A weaker Euro could chase more money into the US Dollar that is already in a bull move. Eventually the stronger US dollar could hurt exports a few months down the road.
In addition, many mortgages in Eastern Europe were written in Swiss Francs because of the low rates. The cost of these mortgages is sure to increase quite dramatically.