Viewpoint / The House Always Wins

Israel's foreign exchange is boiling hot. Thousands, maybe tens of thousands of Israelis discovered the private forex brokerages in the last year, namely, companies with dealing rooms that are unaffiliated with the banks. Anybody can buy or sell foreign currency quickly, cheaply, and with high leverage, too.

But unlike the dealing rooms at the banks, these traders - companies like Easy-Forex Israel, Finotec, Matach24 and Efix Online Forex - are more like a casino than a traditional financial broker.

Say you want to open a position in the forex market, meaning, bet on the fluctuation of one currency against another. Then these companies offer more convenient, cheaper service than the banks.

They proffer many advantages: Nobody asks too many questions. They won't ask you to sign tons of documents. They won't report your profits to the Income Tax Authority. They won't hand your name over to the anti-money laundering authority. After all, they aren't banks, so why not take advantage of that.

Service is fast and low-cost; almost all allow you to give orders via phone or Internet. If you want, they will advise how to invest in the forex market, too. They are reliable, too; there haven't been reports of embezzlements for years.

They generally don't charge fees. The differences between their buy and ask rates are narrower than at the banks. They will let you open an account with amounts of a few thousand dollars or less, which would barely get a bank clerk's attention.

Most importantly, they'll let you gamble heavily. You can enter positions 20 times the amount you deposited. You transferred $5,000? By all means, bet $100,000 on the euro-dollar market.

Call it by name

The word "gamble" in the last paragraph was not chosen by happenstance. The dealing rooms at the banks supply first and foremost forex services for importers and exporters. The other companies mentioned above exist to serve speculators.

Israel may not have casinos by name, but it does in essence: options on the TA-25 index, and gambles on exchange rates. How much? A lot.

Market estimates, perhaps on the optimistic side, put the nominal turnover of forex gambles in Israel, including on the shekel-dollar and other pairs of currencies, at about half a billion dollars a day.

That is not a typo: $500 million, or NIS 2.5 billion, take your pick.

In the forex market, whether at the bank or at one of these brokers, any action a client takes is backed by the company's equity. The banks are worth billions but how do these small dealers back their commitments?

There are two answers to that, one conservative: the small brokers offset one customer against another. In other words, the risk involved in one client betting the euro will rise, is offset by the risk of another customer betting that the dollar will, if the two actions are of the same financial scope. They continuously close open positions by carrying out the opposite action with a big commercial bank, leaving themselves with fundamentally no risk.

But working opposite a big bank carries a heavy cost, and some of these dealers choose another strategy. From experience gained over the years, they know that at the end of the day, their clients will lose money, always. They don't even bother to close their total position; sometimes they do the opposite of what their clients are doing.

That method is exactly what the casinos in Las Vegas do: financial management there is dead simple. It is based on a four-word philosophy: The House Always Wins.

The psychology of gambling

In more than 99 percent of cases, they are right. The psychology of gambling has long proved that when somebody wins, he spends his gains very quickly. But when he loses, he keeps the position open in the hope that at any second, the market will "correct" and he'll recoup his losses.

That does not happen, of course. On average, clients of the forex market dealing rooms lose all their money and leave the game.

And if somebody wins, despite all? He will remain a happy client and will continue to gamble, maybe even increasing the scope of his bet. Ultimately, he will lose all his money and leave the game.

Veteran forex traders know their clients well, and just like casinos on the Strip, they have stats showing how long it takes the average Yossi to lose his pants, and how much money Shmulik will leave on the table.

Let it clearly be stated that all this is perfectly legal. It is the right of any person to speculate in currencies to his heart's content. It is the right of any forex broker to manage its position vis a vis clients as it pleases. But remember:

1. Nobody has ever managed to predict the fluctuations of the forex market.

2. The absolute majority of gamblers in the forex market lose all their money pretty fast and leave the game.

3. It's all a question of probabilities and experience. These small brokers do not have significant equity and if something spins out of control in their reserves management, the few investors who managed to squeeze a little profit out of the system, who guessed the direction of the market, may lose their money after all.