Oliver Cartade, Guest Writer
Fraudulent trading schemes have been commonplace for a long time.
The Commodity Futures Trading Commission (CFTC) is the federal agency that regulates the trading of futures and options contracts in the United States. In recent years, the CFTC has brought numerous enforcement actions against individuals and firms, often unregistered, that offered investments in so-called forex trading programmes and commodity pools where the funds invested were misappropriated or misused - and often spent on improper business or personal expenses - and where the operators advertised and solicited investors based on false claims of high profit and minimal risk.
In Jamaica, however, the average retail investor has not had much exposure to such schemes and is easy prey.
Even when traded legitimately, futures and options contracts are volatile and risky. People who are considering committing their funds to trading forex futures or options should educate themselves about futures and options and realise that they may lose large sums of money.
Gains and losses
Given the volatility and leverage implicit in the foreign exchange market, the potential to make a lot of money is certainly present. However, when you have a trade in the wrong direction, the losses can be just as substantial. Leverage and margin work both ways; there is no 'free lunch'. For a salesperson raising money for forex trading to ignore this risk is not only misleading, but also unethical.
In Sunday Business of October 15, 2006, an article appeared titled "Bold and educated traders can profit from forex trading" by Jared Martinez of Market Traders Institute.
The article is basically a sales pitch outlining only the upside of forex trading without any mention of the risks involved.
It 'cherry-picks' situations where companies and investors made large sums of money using the foreign exchange market and creates an impression that anyone who puts money into forex will make money.
I can point out many instances where the opposite has happened. For example, almost every large company that sells products worldwide will have exchange rate risk and as a result, these companies use currency derivatives to hedge out this risk. So to take a random company like Caterpillar or DaimlerChrystler and use a random year where their currency hedges made money is misleading.
Just to counter, if you take Caterpillar and look at its annual filings, you will see that these same currency trades lost them US$23 million, US$10 million and US$90 million in 1998, 1999 and 2000, respectively .
In addition, famous traders like George Soros and Julian Robertson who amassed fortunes making large currency bets also had huge losses that eventually led to the closure of their funds. For example, on October 7, Robertson suffered a $2 billion loss on the surge of the Japanese yen against the U.S. dollar.
Similarly, Soros suffered a US$600 million loss on February 14, 1994, when he was short a large position of Japanese yen. Both men ended up shutting down their funds. Lastly, in response to Warren Buffet's recent foray into the foreign exchange world, he has lost US$310 million during the first quarter of 2006 from this trade.
That's not to say someone cannot be profitable trading currencies over the long run. There are some great investment managers who do just that. However, their return profiles tend to be very volatile (with many losing months).
The world has become extremely efficient in processing information and for a single manager to be right on balance month after month is simply not possible.
Even the large banks that have their own forex proprietary trading desks - made up of many traders and economists - and much greater access to information are only right 60-70 per cent of the time.
However, they make money over the long run since they cut losses quickly when they are wrong and make large profits when they are right.
Any suggestion of monthly returns of 10 per cent consistently makes me very suspicious.
Firstly, without an audit from a reputable firm, historical returns are absolutely meaningless. And, any manager who fails to provide audited figures raises many red flags and should be avoided at all costs.
Secondly, a detailed breakdown of the fees incurred would need to be disclosed to ensure that the manager is not diverting funds.
I have been investing proprietary money - my group currently has discretion for US$1.5 billion - in various investment vehicles for many years and have a few words of advice for those thinking of allocating their money for someone to manage.
Scepticism
Be sceptical even when you know the person soliciting your investment. Treat any information you are given in the same fashion that you would handle information provided by a stranger - ask questions and investigate what you are being told.
If you cannot get satisfactory answers or are uncertain about any assurances you receive, play it safe. Don't invest, or invest only an amount that you can well afford to lose, especially where the manager claims to have special trading expertise, a unique understanding of relevant market trends, or a record of profitable trading. Such claims by unregistered pool operators often turn out to be false.
Individuals and firms that solicit funds from investors for forex trading are usually not registered with any governmental agency.
They may operate 'ponzi' schemes in which little or none of the money sent in by investors is ever invested as promised - in the forex markets.
Oliver Cartade is Head of Research at Safra Asset Management, New York. Email: oliver.cartade@safrafunds.com.
