Making sense of the SNB decision

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Swiss National Bank

The “Swiss Shocker” is definitely one of the biggest black swan events in the currency markets in recent times. The Franc, considered to be a safe haven, further cemented its position as the “go-to” currency in terms of playing it safe. Traders often made use of the CHF currency, especially the EURCHF and USDCHF as a way to hedge risks on other currencies. However, that status as a “safe bet” has taken a beating for the worse. So what exactly happened yesterday?

The Swiss Floor of 1.20

During the height of the financial crisis in 2008 and the ensuing Greek sovereign debt crisis, the Euro had fallen dramatically in the following years. This decline in turn put pressure on its peripheries such as the UK, Switzerland, Sweden, Denmark and other countries. With the Eurozone being one of Switzerland’s largest trading partner, a higher Swiss Franc made it impossible for Swiss exporters to continue their businesses at a profit. The Swiss Franc also enjoyed a reputation for being a safe haven currency in the West (besides the Yen). Meaning that in times of uncertainty, investors flocked to buy the Swiss Franc or park their investments to hedge against uncertainty. Combining the cash inflows as a result of being a safe haven and a depreciating Euro currency, these capital flows in turn would put downward pressure on the Current Account as well as the overall GDP for Switzerland.

In order to contain the situation, the Swiss National Bank imposed a floor, pegging the Swiss Franc to the Euro in 2011. In other words, 1 Euro bought 1.20 Swiss Francs. By lowering or depreciating the Swiss Franc, the SNB hoped that it would help the economy. At regular intervals, the SNB came out assuring the markets that it would defend the peg and started buying the Euros whenever the EURCHF threatened the 1.20 floor.

At one point soon after the announcement, the markets did test if the SNB was committed and the markets got the answer as the Swiss National Bank intervened in the markets to help lift the Euro back above the 1.20 mark.

Why was the SNB decision a shocker?

When the SNB stunned the markets yesterday, it took everyone by surprise. It was only last week (January 5th, 2015) that Thomas Jordan, Governor of the Swiss National Bank, in an interview with a Swiss television channel reiterated the importance of maintaining the peg of 1.20. The ‘U-turn’ by the Swiss National Bank barely a week later, and that too in an unscheduled policy announcement, the decision to abandon the EURCHF peg, certainly brought with it the element of “awe and shock”, catching the markets off guard.

What went on during the SNB’s announcement?

When the SNB announced that it was abandoning the EURCHF peg and that it was cutting the interest rates further to -0.75% on sight deposits, it was all that was needed for chaos to ensue.

Because of the floor that was maintained, traders took on long positions on EURCHF, meaning they were on the short side of the Swiss Franc, knowing that if price tried to drop to 1.20, the SNB would intervene with its vast forex reserves. The EURCHF long positions (and USDCHF long positions) therefore was probably a safe trade to make and many traders used this to hedge their risks against positions in other currency pairs.

eurchf-peg-timeline

However, with the SNB announcing that it would no longer buy Euros to defend the 1.20 peg, the Swiss Franc rose dramatically, rising as much as 16% against the Euro and many other currency pairs. As the Swiss Franc began to rise, liquidity was sucked out, leaving a large gap in the bid and ask offers (in other words, the Stop loss and take profit orders). At one point, the spread was as high as 1000 pips. Due to the large spike, traders who had any sort of exposure to the Swiss Franc, (meaning that those who had any opening positions in CHF) were victims of illiquidity. They simply couldn’t exit their trades, in some cases for as long as an hour.

Due to the wide spreads, trading accounts that were highly leveraged got a margin call. With the stop loss orders being filled at the best available price within the 1000 pip spike, some traders who managed their positions were able to get out with either a small loss or a reasonable gain. But that wasn’t the story elsewhere as many trading accounts simply got wiped out with some dipping into negative NAV or negative equity.

What can we learn from the SNB’s event yesterday?

  • Black swan events can and do happen from time to time, a risk every trader should bear in mind. No one saw this coming.
  • Money management is essential, especially in terms of position sizing the trades as well as the leverage a trader has on their accounts. Most traders tend to focus on trading strategies, when in reality, at the heart of trading lies money and risk management.
  • Trading is risky and the capital used for trading can be wiped out, it is, therefore, essential that traders only use trading capital that they can afford to lose.
  • Stop loss or take profit orders do not ensure that your order will be filled at the specified price. If the market suddenly becomes illiquid, you are stuck.

Trade Safe!

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