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Former Oanda Corp. CEO Michael Stumm in Hart House at the University of Toronto

Former Oanda Corp. CEO Michael Stumm in Hart House at the University of Toronto

How do you run the world's most innovative online forex trading firm? Add to ...

For the first few years, Oanda made money on a subscription-based computer application that fed data on more than 180 currencies directly into companies’ accounting systems, and an online currency converter that clients could host on their own websites. Early customers included airlines and AOL, as well as several major auditing firms, which needed independent data to review their clients’ forex transactions. Public auditing firms such as Price Waterhouse and Ernst & Young were early adopters. Even tax departments of some countries signed on. By 2000, Oanda had more than 13,000 clients, and was generating almost $1 million a year in revenue. Its currency converter was getting 25 million hits a month.

Those early successes also allowed Stumm and Olsen to see the potential of jumping up to the next level: creating an online forex trading platform of their own. Despite the availability of more accurate rates from Oanda and other new online sources, large spreads persisted at major banks and currency dealers. Then, as now, the latter charged a range of fees, depending on the size of the client. Interbank spreads on major currency pairs, such as U.S. dollar/euro or euro/yen are typically between one-100ths and two-100ths of a percentage point of the transaction value. This means that for a $100,000 transaction, the bank offers to buy a currency for one price, and sell it for $10 more. For companies affiliated with them, banks might offer a 0.25% spread, or $250. Then there is a wholesale rate for commercial transactions with, say, a 0.5% spread, and a retail rate for small individual transactions—credit card purchases, exchanging actual cash, and buying and selling foreign securities—where spreads can range from 1% to 4%.

Stumm and Olsen figured they could offer the little guys the interbank rates and still make money if their trading platform was completely automated. They were also one of several upstart online forex firms that were trying to attract individual day traders. Many of those traders had cut their teeth on soaring North American stock markets during the 1990s. But they were starting to shift over to currencies in the wake of the dot-com bust of 2000 and the switch to decimalized pricing by major stock exchanges. That switch was completed in 2001, and it shrank price increments and profit margins to fractions of a penny per share.

The biggest attraction of currency trading is that it allows the use of hefty amounts of leverage, which can greatly magnify profits from even tiny shifts in exchange rates. In those days, leverage of up to 100-to-1 was common, meaning you could buy a $10,000 currency contract by putting down a deposit of just $100. If you buy the U.S. dollar at parity with the Canadian dollar, and the U.S. dollar gains one cent, that’s a 100% profit. (Lately, U.S. regulators have limited leverage on major world currencies to 50-to-1, and it’s 30-to-1 in Canada. Even that reduced leverage means that only a small fraction of the $4-trillion global daily currency trading volume actually changes hands.)

There wasn’t much competition for the retail forex traders’ business from big banks. They weren’t—and still aren’t—interested in catering to the little guys, who represent less than 5% of global trading volume. None of Canada’s Big Six banks offers online accounts targeted at day traders. The banks have their own currency trading teams, with vast amounts of capital at their disposal. They still charge high rates to their individual retail customers.

Olsen’s Swiss banking family didn’t want to fund a competitor, no matter how small, so he and Stumm gathered up some of their own money. Then they paid four of Stumm’s former students $50,000 apiece over nine months to develop software.

Several major elements were needed for the platform, but they weren’t too difficult for sharp programmers to write cheaply. The system had to accept cash from clients (even from credit cards, which Oanda still does), shoot it into the firm’s bank account, monitor market exchange rates, offer users immediate price quotes (with a small spread), execute trades instantaneously, yet prevent clients from risking too much money.

Limiting that risk was actually fairly simple, too. Every major online trading platform has some form of automatic stop-loss order. If a client put down $100 (Canadian) to buy a $10,000 (U.S.) contract at par, and the greenback declined by one cent, thereby wiping out the deposit, Oanda’s system would then sell the contract—easy to do instantly in the highly liquid market for major currencies. As is also standard practice in the industry, clients had to close all their positions by the end of the day. (Approximately 90% of all currency trading is intraday. Margin charges discourage traders from holding positions overnight.)

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