Better move quickly. REUTERS/Marcos Brindicci MBH/SV It's weird to hear one of the most senior international banking executives you've ever met complain that a big part of his business should be more heavily regulated. But that is what I heard this week in Davos regarding the collapse of several retail foreign currency exchange brokerages, which were beggared by the sudden upward move of the Swiss franc last week when the Swiss National Bank suddenly stopped pegging the currency to the euro.

"I'm a big free markets guy," this CEO said to me, making it plain that it was his personal opinion and not that of his company, "but I think those practises were irresponsible."

The practice we were talking about is letting amateur, non-professional investors — like your mum and dad — trade foreign currencies from their laptops at home, as if they were stocks. Plenty of individuals trade stocks privately, of course. The difference with retail FX is that those individuals are offered leverage on their trades by the brokers. That magnifies their trades multiple times. If a client puts up $10,000 as her 10% "margin" (or cash buffer), for instance, she will be able to trade $100,000 in currency and take the gains on that. She gets the losses too, and those are taken out of her margin. With leveraged trading like this, things can go very wrong very quickly — which is what happened when the Swiss National Bank freaked everyone out by letting its currency float free.

For context, my understanding is that hedge funds and quant funds make investments on 20 - 50% margins, or leverage between 2X and 5X. In the US, regulators allow FX leverage of 50 to 1, according to Bloomberg. Overseas it can be even more, 200X.

Those practises have come at a price. Alpari and Excel Markets have both declared insolvency after being unable to cover their clients' positions in the franc as its value rocketed upwards nearly 30% in a matter of minutes. It was one of the biggest moves since the US dollar abandoned the gold standard in 1971. FXCM may have lost $225 million or more after its clients' margins proved too small to cover their bets. GAIN said it will forgive the negative balances on traders who bet wrong on the franc, understood to be a portion smaller than its book of $640 million. Denmark’s Saxo Bank estimated it lost $107 million. Other institutions, like IG Group, have said they will be able to withstand their losses.

That's not normal. Banks don't usually even have to say, "Hey, it hurts but we'll probably be fine!"

The losses and collapses were small enough that they did not pose a systemic risk to the entire system. Having said that, they do raise the question of why this business even exists in the first place. UK TV channels and web sites are full of ads encouraging people to open FX trading accounts.

But should ordinary people really be trading currency positions from their bedrooms?

Currency risk is not at all obvious. It involves knowing how to judge the relative strengths and weaknesses of various countries' economies, and then factoring in their various central bank interest rates, and then also the inflation rate in those countries, and then, after that, making a judgement about which of those currencies are going to move up or down in relation to each other notwithstanding everything you just learned about GDP and interest rates and inflation. That's just scratching the surface.

Yet Alpari was the shirtfront sponsor of West Ham United FC.

With all due respect to the good people of Upton Park, the idea that Hammers fans are a key demo for retail FX trading is ridiculous.

People who know a little bit about FX trading will generally caution you to stay the heck away from it. It looks relatively safe because currencies don't tend to move dramatically against each other, and the movements they do make are small compared to stocks. That's why these brokerages offer their clients leverage: To make any money you have to bet large sums on tiny movements. Sometimes this is called "picking up pennies in front of steamrollers." As long as the steamroller is moving slowly, you can pick up as many pennies as you want.

Last Wednesday the Swiss took the brakes off their steamroller and let it roll downhill as fast as it wanted.

That steamroller rolled through clients' margins in minutes, wiping them out and leaving them owing millions. Worse, the losses were magnified because the brokerages had offered leverage on those margins and were suddenly unable to cover the trades. Here's a simplified explanation of how this works. Let's say a buyer is willing to buy a currency at 16. And a seller is willing to sell it at 14. The brokerage holds the position between the two, buying at 14 and selling at 16 — it keeps the 2 point spread between the trade. This all happens in real time, in seconds, en masse.

The Swiss problem was that as the franc rocketed skyward, there were no sellers. The brokerages were left holding positions they couldn't cover because there was no available currency to cover them. Or at least, when it became available it was so expensive it was well beyond the collective margins the brokers' clients had deposited.

My source tells me his understanding is that 90% of people who try retail FX trading eventually get blown out, losing their margins. I don't know if that's true — someone must be making money, right? It doesn't matter if it's true, either. That's the perception of the business, and perceptions count.

Unchecked leverage is exactly the problem that killed off Long Term Capital Management in 1998. LTCM was trading at leverage of up to 50X — below the level of leverage currently offered in retail FX. In other words, this is a problem that even very clever people get wrong.

I called GAIN and FXCM to get their side of the story but no spokespeople were available to talk.

From their point of view, however, the losses they saw may have been taken by people who could afford it. InteractiveBrokers had negative customer balances of $120 million, but said that 80% of that was from just five clients. FX traders tend to be rich people who can afford to lose their money. And these companies do adjust margin requirements as the market changes. They're not idiots. They're not just sitting there waiting to get hit by steamrollers.

That's fine. But it doesn't address the central issue: It's a great business to be in as long as the steamroller is moving slowly and nothing unexpected happens. But the problem with unexpected events is that although, by definition, they are not expected to happen now, unexpected events are guaranteed to happen sometime in the future. Unexpectedly!

I think that's why my CEO is so puzzled at retail FX trade brokerages. Why would you engage in a business that wipes you out if you're unlucky just once?