IPOs Raise Questions about the Future of Retail Forex

It has been said before, but now I think it’s official: retail forex has
entered the mainstream. In the month of December, two retail forex
brokerages – Forex Capital Markets (FXCM) and Gain Capital Holdings (GCAP) –
went public on the New York stock exchange. Combined with some juicy information
revealed in their regulatory filings, I think this event raises some interesting
questions about the future of forex.
Some background: both FXCM and Gain Capital operate trading platforms and
news/analysis websites (DailyFX.com and Forex.com, respectively). FXCM has a
current market capitalization of $850 million, compared to $250 million for Gain
Capital. The former earned net income of $98 million last year on revenue of
$339 million, and it has 135,000 active clients. The latter earned $36 million
net income on $188 million revenue, and its client base totals 52,000. (For the
sake of comparison, consider that ETrade has more than $4 million and its ttm
revenues exceeded $2.5 Billion).
If you do some simple arithmetic, you will discover that revenue per account
is substantially higher for forex brokers than for stock brokers: $2,500/account
for FXCM versus $100-200 that I’ve been told is standard for retail stock
brokers. Of course, some of that disparity is natural, given that the average
forex account-holder trades at a higher frequency and higher volume than the
average stock investor, who apparently only makes one round-trip trade per
month, on average. However, the bulk of that discrepancy is probably due to a
lack of transparency/competition.
Although information on average account size was not released, it nonetheless
stands to reason that a significant portion of forex account-holder equity is
being “transferred” to brokers every year. (Interestingly, FXCM
loses money on the majority of its accounts. Accounts worth more than $10K
– which presumably do the most trading – generate the most revenue, and yet more
than half of them are still unprofitable for FXCM).
I think this raises some serious questions about transparency in forex
commissions. While other brokers make money from the bid/ask spread (which also
suffers from a lack of transparency) and by taking offsetting positions, FXCM boasts that it
“makes an identical amount of money in the form of pip markups (which are really
commissions) regardless of whether the customer made or lost money on the
account.” Basically, FXCM matches up buyers/sellers with banks and financial
institutions, and takes a cut for facilitating the transaction. While this is
somewhat less opaque than filling orders directly for customers, the fact that
it doesn’t disclose its commissions should be cause for concern. For the sake of
comparison, consider that when you buy/sell stock, the commission that you pay
the broker is clearly disclosed.
Someone recently asked me if trading commissions (i.e. spreads) in forex were
fair/stable, and in the context of this data, I think it shows that there are is
still room for commissions to fall. As the number of retail forex traders grows,
you would expect spreads to tighten further, and profit/account to decline from
the current level of $700+ per year.
Since both FXCM and Gain Capital are now public companies, they will be
subject to increased scrutiny and regulatory oversight, and will henceforth be
required to make frequent disclosures. If Oanda and other top-tier brokers
accede to competitive pressures and also go public, the result should be
increased transparency for the industry and better pricing for traders. In
short, daily volume figures ($4 Trillion/day) notwithstanding, retail forex
trading still has a ways to go before it can really be compared to retail stock
trading.