Company M provides a foreign exchange trading platform service to clients. The conditions on which Company M provides its service are outlined in disclosure documentation, and that documentation forms the contract between Company M and its clients.
Bai used Company M’s platform to buy and sell foreign currency. One Friday, Bai entered a ‘short position’ on the US dollar against the Japanese yen. Entering a short position essentially means betting that one currency will fall in value, while the other rises. If that happens, you make money. However, if the currency you thought would fall actually rises, you lose money, and you keep losing money if it continues to rise.
When Bai entered his short position that Friday, he also tried to manage his risk by adding a ‘stop-loss’ in case the US dollar actually rose rather than fell. A stop-loss is triggered when the currency rises to your target value (the value specified in your stop-loss), so that you are protected from further loss.
Unfortunately for Bai, he bet the wrong way. The US dollar rose against the Japanese yen, and continued rising. Even worse, between the time the market closed on the Friday and reopened on the Monday, the market ‘gapped’. Gapping occurs when there is a sudden shift in the price from one level to another. When the market gaps, it is not possible to, for example, place an order between the two price levels. Gapping is one of the risks of foreign currency trading, as foreign exchange markets are very volatile.
Because the market gapped, the first available price on the Monday for Bai’s order was higher than his stop-loss price. Bai lost around $14,500. Had the stop-loss triggered as soon as the market hit Bai’s target price, he would have lost only around $3,500.
Bai complained to FSCL. He felt that Company M misled him. Bai had thought that his stop-loss would trigger as soon as the market hit his target price. He said Company M had not properly explained the differences between a ‘stop-loss order’ and a ‘guaranteed stop-loss order’ (which, as its name suggests, is guaranteed to stop a trader’s losses going any higher than the target price, even if the market gaps).
Bai also complained that Company M had never explained the risks of foreign currency trading.
Company M’s view
Company M explained that the system had functioned as it was supposed to. It pointed out that Bai could have added a ‘guaranteed stop-loss order’ to his trade. Company M declined to compensate Bai for his loss.
We reviewed Company M’s disclosure documentation. We considered it to be comprehensive. Gapping was clearly explained, as was the possibility that a ‘stop-loss’ may not be able to be triggered at the target price if the market gaps (unlike a guaranteed stop-loss, which was also explained). We were of the view that Company M adequately advised Bai of the risk of gapping, so he should have been aware of that risk when he added the stop-loss.
We formed a preliminary view that Bai’s complaint should be discontinued. Bai did not take his complaint further.
Key insight for consumers
When people enter into high stakes bets, for example on foreign currency, it is very important that they read the documentation to fully understand the risks – and to ask questions if they don’t understand!