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December 21st 2010

IPOs Raise Questions about the Future of Retail Forex

It has been said before, but now I think it’s official: retail forex has entered the mainstream. In the month of December, two retail forex brokerages – Forex Capital Markets (FXCM) and Gain Capital Holdings (GCAP) – went public on the New York stock exchange. Combined with some juicy information revealed in their regulatory filings, I think this event raises some interesting questions about the future of forex.

Some background: both FXCM and Gain Capital operate trading platforms and news/analysis websites (DailyFX.com and Forex.com, respectively). FXCM has a current market capitalization of $850 million, compared to $250 million for Gain Capital. The former earned net income of $98 million last year on revenue of $339 million, and it has 135,000 active clients. The latter earned $36 million net income on $188 million revenue, and its client base totals 52,000. (For the sake of comparison, consider that ETrade has more  than $4 million and its ttm revenues exceeded $2.5 Billion).

If you do some simple arithmetic, you will discover that revenue per account is substantially higher for forex brokers than for stock brokers: $2,500/account for  FXCM versus $100-200 that I’ve been told is standard for retail stock brokers. Of course, some of that disparity is natural, given that the average forex account-holder trades at a higher frequency and higher volume than the average stock investor, who apparently only makes one round-trip trade per month, on average. However, the bulk of that discrepancy is probably due to a lack of transparency/competition.

Although information on average account size was not released, it nonetheless stands to reason that a significant portion of forex account-holder equity is being “transferred” to brokers every year. (Interestingly, FXCM loses money on the majority of its accounts.  Accounts worth more than $10K – which presumably do the most trading – generate the most revenue, and yet more than half of them are still unprofitable for FXCM).

I think this raises some serious questions about transparency in forex commissions. While other brokers make money from the bid/ask spread (which also suffers from a lack of transparency) and by taking offsetting positions, FXCM boasts that it “makes an identical amount of money in the form of pip markups (which are really commissions) regardless of whether the customer made or lost money on the account.” Basically, FXCM matches up buyers/sellers with banks and financial institutions, and takes a cut for facilitating the transaction. While this is somewhat less opaque than filling orders directly for customers, the fact that it doesn’t disclose its commissions should be cause for concern. For the sake of comparison, consider that when you buy/sell stock, the commission that you pay the broker is clearly disclosed.

Someone recently asked me if trading commissions (i.e. spreads) in forex were fair/stable, and in the context of this data, I think it shows that there are is still room for commissions to fall. As the number of retail forex traders grows, you would expect spreads to tighten further, and profit/account to decline from the current level of $700+ per year.

Since both FXCM and Gain Capital are now public companies, they will be subject to increased scrutiny and regulatory oversight, and will henceforth be required to make frequent disclosures. If Oanda and other top-tier brokers accede to competitive pressures and also go public, the result should be increased transparency for the industry and better pricing for traders. In short, daily volume figures ($4 Trillion/day) notwithstanding, retail forex trading still has a ways to go before it can really be compared to retail stock trading.

IPOs Raise Questions about the Future of Retail Forex

It has been said before, but now I think it’s official: retail forex has entered the mainstream. In the month of December, two retail forex brokerages – Forex Capital Markets (FXCM) and Gain Capital Holdings (GCAP) – went public on the New York stock exchange. Combined with some juicy information revealed in their regulatory filings, I think this raises interesting questions about the future of forex.

Some background: both FXCM and Gain Capital operate trading platforms and news/analysis websites (DailyFX.com and Forex.com, respectively). FXCM has a current market capitalization of $850 million, compared to $250 million for Gain Capital. The former earned net income of $98 million last year on revenue of $339 million, and it has 135,000 active clients. The latter earned $36 million net income on $188 million revenue, and its client base totals 52,000. (For the sake of comparison, consider that ETrade has more  than $4 million and its ttm revenues exceeded $2.5 Billion).

If you do some simple arithmetic, you quickly discover that revenue per account is substantially higher for forex brokers than for stock brokers: $2,500 in the case of FXCM compared to $100-200 that I’ve been told is standard for retail stock brokers. Of course, some of that is to be expected, given that the average forex account-holder trades at a higher frequency and higher volume than stock investors, which apparently only make one round-trip trade per month, on average. While information on average account size was
not released, it nonetheless stands to reason that a significant portion of forex account-holder equity is being “transferred” to brokers every year. (Interestingly, FXCM loses money on the majority of its accounts.  Accounts worth more than $10K – which presumably do the most trading – generate the most revenue, and yet more than half of them are still unprofitable for FXCM).

I think this raises some serious questions about transparency in forex commissions. While other brokers make money from the bid/ask spread (which also suffers from a lack of transparency) and by taking offsetting positions, “FXCM makes an identical amount of money in the form of pip markups (which are really commissions) regardless of whether the customer made or lost money on the account.” Basically, FXCM matches up buyers/sellers with banks and financial institutions, and takes a cut for facilitating the transaction. While this is somewhat less opaque than filling orders directly for customers, the fact that it doesn’t disclose its commissions should be cause for concern. For the sake of comparison, consider that when you buy/sell stock, the commission that you pay the broker is clearly disclosed.

Someone recently asked me if trading commissions (i.e. spreads) in forex were fair/stable, and in the context of this data, I think it shows that there are is still room for commissions to fall further. As the number of retail forex traders grows, you would expect spreads to tighten further, and profit/account to decline from the current level of $700+ per year.

Since both FXCM and Gain Capital are now public companies, they will be subject to increased scrutiny and regulatory oversight, and will henceforth be required to make frequent disclosures. If Oanda and other top-tier brokers accede to competitive pressures and also go public, the result should be increased transparency for the industry. As of yet, I think that daily volume figures ($4 Trillion/day) notwithstanding, retail forex trading still has a ways to go before it can really be compared to retail stock trading.IPOs Raise Questions about the Future of Retail Forex

It has been said before, but now I think it’s official: retail forex has entered the mainstream. In the month of December, two retail forex brokerages – Forex Capital Markets (FXCM) and Gain Capital Holdings (GCAP) – went public on the New York stock exchange. Combined with some juicy information revealed in their regulatory filings, I think this raises interesting questions about the future of forex.

Some background: both FXCM and Gain Capital operate trading platforms and news/analysis websites (DailyFX.com and Forex.com, respectively). FXCM has a current market capitalization of $850 million, compared to $250 million for Gain Capital. The former earned net income of $98 million last year on revenue of $339 million, and it has 135,000 active clients. The latter earned $36 million net income on $188 million revenue, and its client base totals 52,000. (For the sake of comparison, consider that ETrade has more  than $4 million and its ttm revenues exceeded $2.5 Billion).

If you do some simple arithmetic, you quickly discover that revenue per account is substantially higher for forex brokers than for stock brokers: $2,500 in the case of FXCM compared to $100-200 that I’ve been told is standard for retail stock brokers. Of course, some of that is to be expected, given that the average forex account-holder trades at a higher frequency and higher volume than stock investors, which apparently only make one round-trip trade per month, on average. While information on average account size was
not released, it nonetheless stands to reason that a significant portion of forex account-holder equity is being “transferred” to brokers every year. (Interestingly, FXCM loses money on the majority of its accounts.  Accounts worth more than $10K – which presumably do the most trading – generate the most revenue, and yet more than half of them are still unprofitable for FXCM).

I think this raises some serious questions about transparency in forex commissions. While other brokers make money from the bid/ask spread (which also suffers from a lack of transparency) and by taking offsetting positions, “FXCM makes an identical amount of money in the form of pip markups (which are really commissions) regardless of whether the customer made or lost money on the account.” Basically, FXCM matches up buyers/sellers with banks and financial institutions, and takes a cut for facilitating the transaction. While this is somewhat less opaque than filling orders directly for customers, the fact that it doesn’t disclose its commissions should be cause for concern. For the sake of comparison, consider that when you buy/sell stock, the commission that you pay the broker is clearly disclosed.

Someone recently asked me if trading commissions (i.e. spreads) in forex were fair/stable, and in the context of this data, I think it shows that there are is still room for commissions to fall further. As the number of retail forex traders grows, you would expect spreads to tighten further, and profit/account to decline from the current level of $700+ per year.

Since both FXCM and Gain Capital are now public companies, they will be subject to increased scrutiny and regulatory oversight, and will henceforth be required to make frequent disclosures. If Oanda and other top-tier brokers accede to competitive pressures and also go public, the result should be increased transparency for the industry. As of yet, I think that daily volume figures ($4 Trillion/day) notwithstanding, retail forex trading still has a ways to go before it can really be compared to retail stock trading.

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Posted by Adam Kritzer | in Investing & Trading, News | 3 Comments »

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3 Comments of “IPOs Raise Questions about the Future of Retail Forex”

  1. michael Says:

    “Interestingly, FXCM loses money on the majority of its accounts.” you missed the point where FXCM claim to have an ‘agency’ model – meaning they claim not to be a market maker therefore it doesn’t matter to them whether the client is profitable or not – the risk is passed on to various liquidity providers and FXCM may only generate income from spreads/commissions.

  2. Sam Says:

    This can only be good for forex traders.. Now their brokers are finally accountable..

  3. John E. Putman II, CTA Says:

    Hopefully these IPO’s turn out better than Refco’s. That additional scrutiny lead to discovery of $400m+ in bad debt. Most of us who have been around a while know how that turned out. Something I find interesting in your article is the average capitalization of an account. When RefcoFX went under it was the first peak we had at an average account level, at the time it was around $1500 is my memory serves me correctly. It’s interesting to see the growth in funding despite most of the US being feeling the pressure from a long recession and dwindling net-worth.

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