“Leverage is the enemy… The big move, it’s what kills you.”
That’s what Drew Niv said during an interview with Bloomberg News in May 2014
Don’t worry — I didn’t know who Drew Niv was either. But then I don’t trade currency. Ever. The National Futures Association says 72% of people who trade currency end up losing money.
Anyway…
Niv founded a small brokerage company in 1999 that grew into an $800 million company with over 200,000 customers, largely due to the popularity of currency trading. The company did $432 million trailing 12-month revenue and had $327 million in cash and just $187 million in debt.
At least, it did a couple weeks ago…
Today, the cash is gone, and Niv’s firm may owe $225 million. It may be more, as they are still sifting through the ashes.
What happened?
The Swiss franc happened.
You may have heard that the Swiss National Bank (SNB) un-pegged the franc from the euro last week. Switzerland had pegged its currency to the euro to keep the franc weak because people had been buying the franc like crazy.
Nobody really knows why the SNB lifted the peg, but the Swiss franc launched higher in value (as much as 41%) once it was freed from the disastrous euro.
Anybody who was short the franc (betting on a move lower) was crushed.
200-1
Drew Niv’s company is FXCM Inc. It trades on the NYSE under the ticker symbol FXCM.
Last Monday, it closed at $16.65 a share. Yesterday, it closed around $1.60. And even that is only because FXCM got a $300 million lifeline from another company.
You see, last year, FXCM started allowing its customers to use leverage in their currency trading. By the time FXCM realized its customers were leveraged as high as 200-1 against the Swiss franc, it was too late.
I don’t know if FXCM will recover. The point here is about leverage (like margin in your brokerage account).
Leveraged trades can certainly work out. But when they don’t, it’s usually a complete disaster because by the time you are leveraged up, you’re not investing or even trading — you’re gambling.
Drew Niv knew this. He told Bloomberg as much right before he let greed talk him into using leverage. It seems that every few years, some trading firm blows up (MF Global, anyone?), and it’s usually some form of leverage that does it.
Hedge Fund Wiped Out
Everest Capital Global was an $830 million hedge fund. It had been around for 24 years before the Swiss National Bank acted. Now it’s gone. Everest Capital Global lost everything — $830 million in basically one day.
Sure, the firm itself still has $2.2 billion under management. But I found it very interesting the way Bloomberg described the fund manager’s history.
When Russia defaulted in 1998, one Everest fund lost 53%. It was built back up to $3 billion by 2008, when the financial crisis wiped out $1 billion. Again, it was built back up to $3 billion, when the Swiss franc wiped out nearly $1 billion.
There’s an expression out there that says a bull market makes geniuses of us all.
You can see it in the trading of Everest. When the markets are climbing, the funds do great. But the minute they reverse… BOOM! The whole thing blows up, and years’ worth of gains are wiped out.
People, that’s not investing — it’s gambling, because it’s an all-or-nothing proposition. I’m sure the trader felt like a hotshot when his Everest Capital Fund was up 41% in 2013. Now he’s probably telling himself he “can get back on top” in a year or two.
Whatever, playa’.
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Not Just Hedge Funds
The Financial Times reports that 150 to 175 billion Swiss francs may have been sold short. So we haven’t heard the end of this.
Both Citigroup and Deutsche Bank lost over $150 million. Credit Suisse likely lost around $0.20 a share, which would be as much as $320 million.
Credit Suisse reports earnings on February 2, so we’ll know more then, I expect.
Switzerland’s other big bank, UBS, hasn’t said anything about its Swiss franc losses. That’s probably a bad sign…
None of the Swiss franc losses really affect me. And I doubt they affect you, either. Still, there is a lesson to be learned here, and it’s this: Invest, don’t gamble.
Investing works over time. Gambling leads to inevitable blow-ups and may even wipe you out.
And especially don’t use leverage or margin.
But there’s also this lesson: Everything goes according to plan until it doesn’t.
That’s how the world works. It’s not orderly, and it’s not predictable. So lend some predictability to your investments by owning dividend stocks to get regular income and take advantage of compounding, using trailing stops to avoid big losses, using ETFs and solid blue chips to mitigate single-stock disasters, and doing good research.
Until next time,
Until next time,
Briton Ryle
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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.
