Like other financial markets, the foreign exchange markets have seen a transformation in the composition of the participants. There are many more shops that rely on high tech to trade often for clients, and then there are more individual investors that trade for their own account.
As with any legitimate market participant, any legal means of providing market liquidity should be welcome. However, there is now concern from the National Futures Association about traders from both ends of the spectrum: institutions that deploy high-frequency trading strategies and also individuals who may use credit cards as a means of financing.
In any financial market, there is a need to have as broad a constituency as possible. A broad constituency will deliver the most liquidity. It will also bring more innovation to the marketplace, and with more participants in the market there will be more support. Any marketplace should not rely just on large institutions since individual investors have been shown to make up an important part of many different financial marketplaces.
The National Futures Association’s Compliance and Risk Committee (CRC) is seeking to deny individual customers from trading with credit card supplied capital. There are concerns that this is not the proper deployment of risk capital and it is a risky way to add capital to the marketplace. However, there is little of substance to back this concern up.
Currently there are enforcement mechanisms in place that will prevent credit card borrowing abuse. The safeguards will minimize the damage, if any, to the individual investor. Although funding from credit cards is frowned upon by brokerages, it has historically provided the funding for many successful business ventures. For instance, the founders of Google utilized credit card financing. If used correctly and responsibly credit card financing can provide readily available funds for investment or business activities, either in foreign exchange trading or creating a search engine company. For individual traders and others to prosper, there must adequate liquidity in the foreign exchange marketplace. Most of the liquidity is being provided by high frequency traders, especially in the equities market.
The Dow Jones Industrial Average is now at an all time high. That is due to the buying of institutional investors, not individuals. In the market rally, individual investors have been sitting out the rebound, in large part. While many are starting to return, it has been the institutions that have brought The Big Board and other bourses back.
Like the equities markets the foreign exchange markets should encourage individual investors and not act to deny this important source of liquidity to the venues. As the stock markets have clearly demonstrated since The Great Recession, the individual investor alone cannot be counted on to finance a revival. But they do play an important role in a properly functioning and liquid marketplace. There are too many alternative investments available to individuals, such as real estate, that can divert needed capital to the financial markets.
In short, liquidity in all its legal forms should be welcomed by the foreign exchange markets. There are enough control mechanisms, both individual and institutional, to prevent abuses. While abuses will certainly occur, the overwhelming amount of positive developments far exceeds the negative so that institutions, high frequency traders and individuals — some of whom may deploy funds from credit cards — should be allowed to participate in foreign exchange buying and selling, as long as it is in a responsible manner.
Marcus Holland is Editor of FinancialTrading.com, an educational resource on derivative instruments. Marcus graduated from the University of Plymouth in 2005 with an Honors degree in Business and Finance and has since been trading the financial markets, with a particular focus on forex.