Saturday, July 17, 2010

Brokerages, Institutional Investors,Retail Investors and Forex Scam

Perhaps consistent with these two opposing views is that, as with any type of trading, market timing is difficult to carry out on a consistent basis, particularly for the individual investor unschooled in technical analysis. Retail brokers are also generally unschooled in both the mind set and the tools needed to successfully time the market, and indeed most are actively discouraged by the brokerages themselves from moving their clients in and out of the market. However, as market makers, many of these same brokerages take the opposite approach with their large institutional clients, trading various financial instruments for these clients in an attempt to "predict future market price movements" and thereby make a profit for the institutions. This dichotomy in the treatment of institutional vs. retail clients can potentially be controversial for the brokerages. It may suggest for example that retail brokers and their clients are discouraged from market timing, not because it doesn't work, but because it would interfere with the brokerages' market maker trading for their institutional clients. In other words, retail clients are encouraged to buy and hold so as to maintain market liquidity for the institutional trading. If true, this would suggest a conflict of interest, in which the brokerages are willing to sacrifice potential returns for the smaller retail clients in order to benefit larger institutional clients.

The 2008 decline in the markets is instructive. While many retail brokers were instructed by their brokerages to tell their clients not to sell, but instead "look to the long term", the market makers at those same brokerages were busy selling to cash to avoid losses for the brokerages' large institutional clients. The result was that the retail clients were left with huge losses while the institutions fled to the safety of short term bonds and money market funds, thereby avoiding similar losses.

Curve fitting and over-optimization
A major stumbling block for many market timers is the phenomenon of curve fitting. This means that a given set of trading rules has been over-optimized to fit the particular dataset for which it has been back-tested. Unfortunately, if the trading rules are over-optimized they often fail to work on future data. Market timers attempt to avoid these difficulties in a number of ways. One is by looking for clusters of parameter values which work particularly well. Another is using out-of-sample data, which ostensibly allows the market timer to see how the system will work on unforeseen data. However, critics charge that once the strategy has been revised to reflect such data it is no longer "out-of-sample".

Independent review of market-timing services
Several independent organizations (e.g., Timer Digest and Hulbert Financial Digest) have tracked some market timers' performance for over thirty years. These organizations have found that purported market timers in many cases do no better than chance, or even worse. However, there are exceptions, with some market timers over the thirty year period having performances that substantially and reliably exceed those of the general stock market or the sectors in which that the market timers invest. Jim Simons' Renaissance Technologies Medallion Hedge Fund has consistently outperformed the market. The fund allegedly uses mathematical models developed by Elwyn Berlekamp.

Efficient market theory has also been criticized as an unscientific theory. That is, it assumes the null hypothesis is true (nothing can predict the market), which is the reverse of standard Popperian methodology.
A recent study suggested that the best predictor of a fund's consistent outperformance of the market was low expenses and low turnover, not pursuit of a value or contrarian strategy. However, other studies have concluded that some simple strategies will outperform the overall market. One market-timing strategy is referred to as Time Zone Arbitrage.

Scandal wrongly tainting legitimate market timing
A scandal erupted in the United States in 2007 where some mutual funds "secretly" allowed select investors to rapidly trade the portfolio despite statements banning the practice in the prospectus. The scandal did not involve market timing per se, and market timing is not itself illegal. The scandal involved permitting selected investors to make frequent and repeated trades during the day while permitting general investors to trade only at the close of business, which permitted the favored investors to take advantage of market-timing strategies. "A double standard that favors one investor at the expense of another is illegal and undermines the credibility of the industry." In this instance, the market timing frequently involved predictions of the performance of how international markets would respond to the day's trading in the US. This scandal also involved late trading.
Although the illegal activities of this scandal had nothing to do with legitimate market timing, some in the brokerage and mutual fund industries have nevertheless attempted to link the two. While the motives for doing this remain unclear, one view is that doing so is consistent with the industries' long held view that retail investors should avoid trading and instead buy and hold, despite the potential for market losses.

Evidence against market timing
Mutual fund flows are published by organizations such as Investment Company Institute and TrimTabs. These show that flows generally track the overall level of the market. For example, in the beginning of the 2000s, the largest inflows to stock mutual funds were in early 2000 while the largest outflows were in mid 2005. It is good to note that these mutual fund flows were near the start of a significant bear (downtrending) market and bull (uptrending) market respectively. A similar pattern is repeated near the end of the decade.

This mutual fund flow data seems to indicate that most investors (despite what they may say) actually follow a buy high, sell low strategy. Studies confirm that the general tendency of investors is to buy after a stock or mutual fund price has already increased. This creates a surge in the number of buyers which then drives the price even higher. However, eventually, the supply of buyers becomes exhausted, and the demand (supply and demand) for the stock declines and the stock or fund price also declines.

The famous Dalbar study found that the average investor's return in stocks is much less than the amount that would have been obtained by simply holding an index fund consisting of all stocks contained in the S&P 500 index.
A recent study suggests that corporations and investment banks cannot time the credit markets. They show that investment banks such as Goldman Sachs do as poorly as firms like Ford when it comes to timing the issuance of their bonds.
The efficient-market hypothesis (EMH) says that market-timing strategies can not work. It says that investors can't "beat the market"; interestingly, it says that investors can't do worse (on average) than the market either. EMH says that the investment return created by a strategy that is 50% of the time in cash and 50% of the time in stocks should be similar to a strategy that is 50% invested in stocks and 50% in cash at all times (plus variations for random error).
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Reliance Industries
Reliance Industries Limited (BSE: 500325‎, LSE: RIGD) is India's largest private sector conglomerate company by market value, with an annual turnover of US$ 44.6 billion and profit of US$ 3.6 billion for the fiscal year ending in March 2010 making it one of India's private sector companies, being ranked at 264th position in the Fortune Global 500 (2009) and at the 126th position in the Forbes Global 2000 list (2010).

Reliance was founded by the Indian industrialist Dhirubhai Ambani in 1966. Ambani has been a pioneer in introducing financial instruments like fully convertible debentures to the Indian stock markets. Ambani was one of the first entrepreneurs to draw retail investors to the stock markets. Critics allege that the rise of Reliance Industries to the top slot in terms of market capitalization is largely due to Dhirubhai's ability to manipulate the levers of a controlled economy to his advantage. Though the company's oil-related operations form the core of its business, it has diversified its operations in recent years. After severe differences between the founder's two sons, Mukesh Ambani and Anil Ambani, the group was divided between them in 2006. In September 2008, Reliance Industries was the only Indian firm featured in the Forbes's list of "world's 100 most respected companies

Stock
According to the company website "1 out of every 4 investors in India is a Reliance shareholder." . Reliance has more than 3 million shareholders, making it one of the world's most widely held stock. Reliance Industries Ltd, subsequent to its split in January 2006 has continued to grow. Reliance companies have been among the best performing in the Indian stock market.

Major Subsidiaries & Associates
Reliance Petroleum Limited (RPL) was a subsidiary of Reliance Industries Limited (RIL) and was created to exploit the emerging opportunities, creating value in the refining sector worldwide.Currently, RPL stands amalgamated with RIL.
Reliance Life Sciences is a research-driven, biotechnology-led, life sciences organization that participates in medical, plant and industrial biotechnology opportunities. Specifically, these relate to Biopharmaceuticals, Pharmaceuticals, Clinical Research Services, Regenerative Medicine, Molecular Medicine, Novel Therapeutics, Biofuels, Plant Biotechnology and Industrial Biotechnology.
Reliance Industrial Infrastructure Limited (RIIL) is engaged in the business of setting up / operating Industrial Infrastructure that also involves leasing and providing services connected with computer software and data processing.
Reliance Institute of Life Sciences (Rils), established by Dhirubhai Ambani Foundation, is an institution of higher education in various fields of life sciences and related technologies.

Reliance Logistics (P) Limited is a single window solutions provider for transportation, distribution, warehousing, logistics, and supply chain needs, supported by in house state of art telematics and telemetry solutions.
Reliance Clinical Research Services (RCRS), a contract research organization (CRO) and wholly owned subsidiary of Reliance Life Sciences, has been set up to provide clinical research services to pharmaceutical, biotechnology and medical device companies.

Reliance Solar, The solar energy initiative of Reliance aims to bring solar energy systems and solutions primarily to remote and rural areas and bring about a transformation in the quality of life.
Relicord is the first and one of the most dependable stem-cell banking services of South East Asia offered by Mukesh Ambani controlled Reliance Industries.
Infotel Broadband is a broadband service provider, it is wholly owned by RIL for Rs 4,800 crore.

Forex scam
A forex (or foreign exchange) scam is any trading scheme used to defraud traders by convincing them that they can expect to gain a high profit by trading in the foreign exchange market. Currency trading "has become the fraud du jour" as of early 2008, according to Michael Dunn of the U.S. Commodity Futures Trading Commission. But "the market has long been plagued by swindlers preying on the gullible," according to the New York Times. "The average individual foreign-exchange-trading victim loses about $15,000, according to CFTC records" according to The Wall Street Journal. The North American Securities Administrators Association says that "off-exchange forex trading by retail investors is at best extremely risky, and at worst, outright fraud."
"In a typical case, investors may be promised tens of thousands of dollars in profits in just a few weeks or months, with an initial investment of only $5,000. Often, the investor’s money is never actually placed in the market through a legitimate dealer, but simply diverted – stolen – for the personal benefit of the con artists."
In August, 2008 the CFTC set up a special task force to deal with growing foreign exchange fraud.” In January 2010, the CFTC proposed new rules limiting leverage to 10 to 1, based on " a number of improper practices" in the retail foreign exchange market, "among them solicitation fraud, a lack of transparency in the pricing and execution of transactions, unresponsiveness to customer complaints, and the targeting of unsophisticated, elderly, low net worth and other vulnerable individuals."

The forex market is a zero-sum game, meaning that whatever one trader gains, another loses, except that brokerage commissions and other transaction costs are subtracted from the results of all traders, technically making forex a "negative-sum" game.
These scams might include churning of customer accounts for the purpose of generating commissions, selling software that is supposed to guide the customer to large profits, improperly managed "managed accounts", false advertising, Ponzi schemes and outright fraud. It also refers to any retail forex broker who indicates that trading foreign exchange is a low risk, high profit investment.
The U.S. Commodity Futures Trading Commission (CFTC), which loosely regulates the foreign exchange market in the United States, has noted an increase in the amount of unscrupulous activity in the non-bank foreign exchange industry.
An official of the National Futures Association was quoted as saying, "Retail forex trading has increased dramatically over the past few years. Unfortunately, the amount of forex fraud has also increased dramatically." Between 2001 and 2006 the U.S. Commodity Futures Trading Commission has prosecuted more than 80 cases involving the defrauding of more than 23,000 customers who lost $350 million. From 2001 to 2007, about 26,000 people lost $460 million in forex frauds. CNN quoted Godfried De Vidts, President of the Financial Markets Association, a European body, as saying, "Banks have a duty to protect their customers and they should make sure customers understand what they are doing. Now if people go online, on non-bank portals, how is this control being done.

Not beating the market
The foreign exchange market is a zero sum game in which there are many experienced well-capitalized professional traders (e.g. working for banks) who can devote their attention full time to trading. An inexperienced retail trader will have a significant information disadvantage compared to these traders.
Although it is possible for a few experts to successfully arbitrage the market for an unusually large return, this does not mean that a larger number could earn the same returns even given the same tools, techniques and data sources. This is because the arbitrages are essentially drawn from a pool of finite size; although information about how to capture arbitrages is a nonrival good, the arbitrages themselves are a rival good. (To draw an analogy, the total amount of buried treasure on an island is the same, regardless of how many treasure hunters have bought copies of the treasure map.)

Retail traders are - almost by definition - undercapitalized. Thus they are subject to the problem of gambler's ruin. In a fair game (one with no information advantages) between two players that continues until one trader goes bankrupt, the player with the lower amount of capital has a higher probability of going bankrupt first. Since the retail speculator is effectively playing against the market as a whole - which has nearly infinite capital - he will almost certainly go bankrupt.
The retail trader always pays the bid/ask spread which makes his odds of winning less than those of a fair game. Additional costs may include margin interest, or if a spot position is kept open for more than one day the trade may be "resettled" each day, each time costing the full bid/ask spread.
According to the Wall Street Journal (Currency Markets Draw Speculation, Fraud July 26, 2005) "Even people running the trading shops warn clients against trying to time the market. 'If 15% of day traders are profitable,' says Drew Niv, chief executive of FXCM, 'I'd be surprised.
Paul Belogour, the Managing Director of a Boston based retail forex trader, was quoted by the Financial Times as saying, "Trading foreign exchange is an excellent way for investors to find out how tough the markets really are. But I say to customers: if this is money you have worked hard for – that you cannot afford to lose – never, never invest in foreign exchange.

The use of high leverage
By offering high leverage, the market maker encourages traders to trade extremely large positions. This increases the trading volume cleared by the market maker and increases his profits, but increases the risk that the trader will receive a margin call. While professional currency dealers (banks, hedge funds) seldom use more than 10:1 leverage, retail clients are generally offered leverage between 50:1 and 200:1.
A self-regulating body for the foreign exchange market, the National Futures Association, warns traders in a forex training presentation of the risk in trading currency. “As stated at the beginning of this program, off-exchange foreign currency trading carries a high level of risk and may not be suitable for all customers. The only funds that should ever be used to speculate in foreign currency trading, or any type of highly speculative investment, are funds that represent risk capital; in other words, funds you can afford to lose without affecting your financial situation.

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