For three years and four months, EUR/CHF had a floor. The Swiss National Bank had promised that the euro would not trade below 1.20 francs, and it kept the promise by buying euros whenever the price got close. Traders built whole strategies on the assumption that the line would hold.
On the morning of Thursday, January 15, 2015, the SNB announced that it was discontinuing the minimum exchange rate. The euro dropped from just above 1.20 to around 0.85 francs within minutes, then recovered to roughly 1.02 to 1.04 later in the day, according to CNBC and Reuters reports from the session. Switzerland’s main stock index, the SMI, closed down 8.7%.
For a major currency pair, a move like that is extraordinary. What made the day so damaging for retail traders, though, was how the price got from 1.20 to 0.85: with almost no trading in between.
Why the floor existed
The SNB set the floor on September 6, 2011. The euro area debt crisis had sent investors looking for a safe place to keep money, and the franc had risen so fast that the central bank described the overvaluation as “an acute threat to the Swiss economy.” Its statement said it would enforce the minimum rate “with the utmost determination” and was prepared to buy foreign currency in unlimited quantities.
That kind of promise is believable when a central bank is trying to stop its own currency from rising, because it can create as many francs as it likes. The cost appears somewhere else. Every intervention added more euros to the SNB’s balance sheet, and a central bank sitting on a growing pile of foreign assets takes a loss if that currency falls.
By early 2015 the euro was falling. Markets widely expected the European Central Bank to begin large-scale bond purchases, and it announced them a week later, on January 22. Holding 1.20 against a currency that was about to be created in much larger quantities would have meant buying euros on a much bigger scale. In explaining the decision, SNB Chairman Thomas Jordan pointed to the growing divergence between the monetary policies of the major currency areas and said that keeping the minimum rate was “no longer justified.”
The SNB also cut the interest rate on sight deposits above an exemption threshold to -0.75%, to make holding francs less attractive. It did not stop the rush.
The timing added to the shock. The announcement came between the SNB’s scheduled quarterly policy assessments, so there was no date on the calendar that would have told a cautious trader to step aside.
Why stop-losses did not save anyone
A stop-loss order is an instruction to close a position once the price reaches a set level. Most retail stops turn into market orders when they are triggered, which means they are filled at the next price someone is willing to trade at. On a normal day that is very close to the stop level.
On January 15, buyers of euros against the franc vanished for a while. Liquidity providers pulled their prices. When quotes came back they were far lower, and stop orders resting at 1.1950 or 1.1900 were filled wherever the market happened to be. Fills varied widely from broker to broker, depending on who they were trading with and when they could get prices at all.
Here is how that could look for a hypothetical trader. The numbers are illustrative and do not come from any real account.
- Account balance: $10,000
- Position: long one standard lot of EUR/CHF, which is 100,000 euros, at 1.2010
- Stop-loss: 1.1960, or 50 pips away, a planned risk of about CHF 500
- Actual fill: 1.0500
The loss on the position is 100,000 × (1.2010 – 1.0500) = CHF 15,100. With USD/CHF trading near 0.88 that afternoon, that comes to roughly $17,000. The trader planned to lose about $500 and instead lost the whole account, and still owed the broker around $7,000.
This is the part many beginners miss. A stop-loss limits the damage when prices move in a normal, continuous way. When the market jumps, the stop is only a request to get out at the first available price.
Brokers went down too
When a client’s account goes negative, the broker is the one owed the money. On January 15 a number of brokers discovered they were owed far more than they could ever collect.
FXCM, then one of the biggest retail forex brokers in the United States, said client debit balances left it with losses of about $225 million and put it in breach of regulatory capital requirements. The next day it took a $300 million emergency loan from Leucadia National, the parent of Jefferies, at an initial interest rate of 10% that could climb as high as 17%. FXCM later forgave the large majority of the client accounts that had gone negative.
Alpari UK, a London broker, said on January 16 that it had entered insolvency, explaining that client losses had exceeded their account equity and been passed on to the firm. At least one New Zealand broker shut down, and London Capital Group said its own exposure could reach £1.7 million.
In each case the mechanics were similar. Brokers had either passed client trades on to banks that gave them equally poor fills, or kept the risk on their own books. Either way, client losses beyond the money in their accounts ended up as the broker’s problem.
What changed afterwards
Regulators drew their own conclusions. In 2018 the European Securities and Markets Authority restricted contracts for difference sold to retail clients in the EU, a category that covers rolling spot forex. From August 1, 2018, leverage on major currency pairs was capped at 30:1 and lower on other instruments. Brokers had to close a client’s positions once margin fell to 50% of the required minimum, and retail clients got negative balance protection, meaning they cannot lose more than the money in their account. The UK’s Financial Conduct Authority and other national regulators later made similar rules permanent.
In the United States, retail forex leverage had been capped at 50:1 on major pairs and 20:1 on others since 2010, under rules from the Commodity Futures Trading Commission.
Some brokers also sell guaranteed stop-loss orders, which close a position at exactly the stop price even if the market gaps. They cost extra, and the terms vary by provider.
Negative balance protection caps your loss at your deposit. A gap like the one in January 2015 would still take all of it.
What traders can take from it today
Treat any fixed or managed exchange rate as an arrangement that can end suddenly. Hong Kong has kept its dollar inside a 7.75 to 7.85 band against the US dollar since 2005, and Denmark keeps the krone close to the euro under the ERM II mechanism. Neither shows any sign of ending, and this is not a prediction that either will. The point is that a currency which has barely moved for years can still carry very large risk, and that risk does not show up in its recent volatility.
Size positions with gaps in mind. If a sudden 10% move in a pair would do serious damage to your account, the position is probably too big, whatever your stop-loss says.
Learn how your broker works before you need to. Find out which regulator supervises it, whether negative balance protection applies to your account, how client money is held and whether guaranteed stops are available. Those answers take ten minutes to find on a quiet day and are very hard to get in the middle of a crisis.
Be wary of trades that only look safe because someone else is absorbing the risk. Buying EUR/CHF just above 1.20 with a tight stop looked close to riskless for more than three years. It stayed that way only as long as the SNB was willing to keep paying for it.
Sources
- Thomas Jordan, “The rationale for discontinuing the minimum exchange rate and lowering interest rates,” via the Bank for International Settlements
- ESMA: final product intervention measures on CFDs and binary options, June 2018
- Finance Magnates: Alpari UK enters insolvency, January 16, 2015
- CNBC: Swiss franc soars after SNB drops cap on currency
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