News & Analysis

Exotic or quixotic! Major currency advantage as black market wreaks FX trading havoc

Andrew Saks, Monday, 26 April 2021

The stability of the currency markets which are largely centered around the six majors has been something of a double-edged sword for a very long time now.

On one hand, the steady ebbs and flows upward and downward are testimony to the organized structure and high-quality business environments of the nations which issue the major currencies and whose national economies create tremendous wealth, and on the other hand, FX trading has been a relatively low margin business for many years due to what one particular FX industry executive publicly said over ten years ago in that "We have not seen proper volatility for over two decades".

Here we are, ten years on from that statement and stability is still the order of the day, hence now we are well into three decades of low volatility in the markets, to the point that many FX brokerages have based their entire b-book business model on internalized risk management with low volatility as a key tenet.

At the beginning of this year, the inability to cope with volatility by many market participants was exposed as candidly as a politician on Clapham Common to a tabloid newspaper when the now-infamous meme stock debacle occurred in January.

During that period, even some of the longest established retail FX and CFD brokerages locked their clients out of their trading accounts whilst trades were open, resulting in tremendous anguish.

As much as discretion is the better part of valour, ETX Capital demonstrated its prowess during that period as every trader was able to continue trading as normal, without any unusual impositions or restrictions, and with access to all markets functioning as usual during a period which demonstrated the shift toward people power in influencing the markets.

It is imperative to move with the times, and as the Reddit subgroup which focused on GameStop began to create enough waves in the market for some brokers to lock their clients out, ETX Capital's traders remained calmly in control of their assets.

For those who are in search of some excitement and wish to seek out genuine volatility in a retail FX market which has built itself around the complete opposite, there is a new and interesting dynamic, that being the 22 central banks in nations which are nowhere near major currency issuers have been unable to do what they spend most of their time doing when there are no lockdowns: fighting unofficial currency markets.

Today the extent of the blind eye that has been turned by 22 central banks as a result of their offices having been locked down which in turn has caused a shortage of staff has made its presence known in a report by the Institute of International Finance (IIF).

According to the report, circumstances which cause official rates to differ sharply from the rates available to ordinary people or businesses can cause a range of economic problems.

Yes, indeed, but this creates volatility and therefore FX trading opportunity.

The report said that parallel market (official politically correct speak for black market) rates in March 2021 exceeded the official exchange rates by 720% in Lebanon, 520% in Turkmenistan and 490% in Iran.

Lebanon joined the “club of problematic currencies” in late 2019 when political paralysis led to a sharp loss of confidence, the report said.

An official exchange rate significantly stronger than a market-clearing rate will discourage FDI (foreign direct investment), reduce the interbank FX market, encourage rent-seeking, and impede business development” said Garbis Iradian, IIF chief economist for the Middle East, North Africa, Caucasus and Central Asia.

The market ripples caused by such black markets are not new. Nigeria, a country in which many retail FX traders reside, its naira currency being a longstanding subject of several parallel markets.

Many attempts by the government have been made to stem this, however back in 2016, one particular FX trader explained to me "“In Nigeria, where there is currently a fantastic opportunity and great potential, due to the devaluation of the naira. Nigeria is an attractive destination for international brokers to set up, many brokers have been there for some years now. it is important to take this opportunity to set up an office for very little money."

Just a few days after that conversation, Nigeria's Minister of Finance, Mrs. Kemi Adeosun said that The Central Bank of Nigeria (CBN) plans to put an end to the spread difference between Interbank and Parallel FX rate, which will go a long way in assisting business owners in Nigeria who are presently suffering due to the high exchange rate.

This never happened and volatility is still very high.

Some seasoned traders call these types of currencies "exotic", the definition of which being currency pairs which are the sovereign tender of developing countries as well as several developed European countries which are traded less frequently. The group of exotic currencies was formed by the means of the International Monetary Fund, and exotic currency pairs are usually highly volatile and are lacking liquidity.

Indeed, they may lack liquidity, but that is not necessarily a concern for retail FX traders who face brokers with a benevolent b-book execution methodology, meaning a broker which manages its own risk book using a genuine market price, rather than exporting risk to a live market at Tier 1 banks which may reject the order flow or conduct last look practice.

It may be the office closures that have fanned the flames of the creators of black currency markets in 22 countries, however these are commonplace and have been for some time.

The opportunity lies in where these are magnified.

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