A forex scam is any trading scheme used to defraud individual traders by convincing them that they can expect to profit by trading in the foreign exchange market. These scams might include churning of customer accounts for the purpose of generating commissions, selling software that is supposed to guide the customer to large profits (see, e.g. James Dicks), improperly managed "managed accounts," ^*," target="_blank" >false advertising ^*" target="_blank" >and outright fraud ^*. It also refers to any retail broker who indicates that trading foreign exchange is a reasonably safe and profitable method of investment.

The U.S. Commodity Futures Trading Commission (CFTC), which loosely regulates the foreign exchange market in the United States, has noted an increase in the amount of unscrupulous activity in the non-bank foreign exchange industry ^*.

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 and 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 retail FX industry, the OTC nature of the market, and the loose regulation of the market, leaves retail speculators vulnerable. Defrauded traders and regulatory authorities, can find it very difficult to prove that market manipulation has occured since there is no central currency market, but rather a number of more or less interconnected marketplaces provided by interbank market makers.

CFTC Warnings

---

The CFTC lists 9 warning sign for foreign exchange trading fraud^*.

1. Stay Away From Opportunities That Sound Too Good to Be True

2. Avoid Any Company that Predicts or Guarantees Large Profits

3. Stay Away From Companies That Promise Little or No Financial Risk

4. Don't Trade on Margin Unless You Understand What It Means

5. Question Firms That Claim To Trade in the "Interbank Market"

6. Be Wary of Sending or Transferring Cash on the Internet, By Mail or Otherwise

.... Be especially alert to the dangers of trading on-line.

7. Currency Scams Often Target Members of Ethnic Minorities

8. Be Sure You Get the Company's Performance Track Record

9. Don't Deal With Anyone Who Won't Give You Their Background

The disadvantages of retail speculators

---

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 attention full time to trading. An inexperienced retail trader will have a significant information disadvantage compared to these traders.

Retail speculators are almost always undercapitalized, and as such are subject to the problem of Gambler's Ruin. In a fair game (e.g. 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. Any speculator who plays this strategy (i.e., gambling with no skill at forecasting market direction) 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—needs to carefully consider if they can "beat the market" using a profitable 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, and 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.

According to the Wall Street Journal ("Currency Markets Draw Speculation, Fraud", July 26, 2005), "Even people running the trading shops warn clients against trying to time the market. 'If 15% of day traders are profitable,' says Drew Niv, chief executive of FXCM, 'I'd be surprised.'" ^*

Additional disadvantages when dealing with market makers

---

The spot currency trades placed by retail speculators (traders) are made directly with the trader's own "market maker"; that is, the market maker is the counterparty and takes the other side of the transaction. Thus, many of spot trades never enter the interbank market.

Retail speculators (traders) are less vulnerable to being scammed if the broker passes the spot trades directly to the interbank market, without the use of a dealing desk. The claim "No Dealing Desk", used in advertising by various forex brokers, is not a guarantee to the trader, and does not define how spot trades are actually made.

When trading with any dealing desk, speculators (traders), especially low-capital retail speculators, suffer from many disadvantages including the following:

• Unless they have accounts at different firms, they have no competitive prices to trade against; i.e., they must accept their market maker price or not trade.
• The market maker may or may not show them the actual prices from the forex market; there may be a delay or "price shading", where prices displayed are off market (e.g., a given rate is shown slightly higher than on the interbank market if the market maker expects the price to increase, though protected against arbitrage by the spread). Thus the market maker has better information with which to determine what prices to display.
• Traders are often encouraged to over-leverage their positions, increasing the likelihood traders will receive a margin call, which will close their positions immediately.

The use of high leverage

---

By offering high leverage, the market maker encourages traders to trade extremely large positions. This increases the trading volume cleared by the market maker 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. Retail FXs will do anything to get the customer's money deposited with them, since eventually all this money becomes theirs.

The use of stop loss orders

---

Retail market makers will often encourage their clients to trade on margin and set stop loss orders, which allow the market makers to close out trades almost at will during busy markets at prices they have set. If the market maker does not offset the trader's position, the loss generated when a stop loss is triggered becomes the market maker's gain.

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

The vast majority of retail FX traders are not profitable. For those losing retail speculators, much of the funds they had on deposit will be, in some form or another, transferred to the market maker.

Trader Recourse and Anticipated Changes Within the Forex Market

---

Traders have recourse to dedicated blogs and forums to document the risks, scams and unfair practices associated with dealing desks [http://www.prweb.com/releases/2006/6/prweb396948.htm Such blogs and forums hold the possibility of creating change within the retail forex industry. The retail forex industry also faces structural change as a result of larger entities creating a centrally cleared marketplace. Such centralization will of necessity demand greater scrutiny and enforcement. ^{* *}

See also

---

• Boiler room
• Bucket shop
• Gambler's ruin

External links

---

• ^* is an example considered by one editor to be a forex scam. A different editor views obviously risky forex sites as a contrived effort to distract the public, as well as regulatory and enforcement bodies, from greater wrong doings within the retail forex industry.

Foreign exchange market