Tag Archives: CFTC

Did you know the members of the Currensee social network are significantly better performers than the general population of forex traders?

It’s true. I’ll run you through the numbers.

As a basis for comparison I’m using the quarterly figures the Commodity Futures Trading Commission (CFTC) requires US forex brokers to report. They show the percentage of active accounts which are profitable in each period. Active here means an account which has done at least one trade over the three months in question. Forex Magnates aggregates this information each quarter. You can see the figures for Q1 of 2013 here.

The broker-reported figures started for Q4 of 2009. In order to do the comparison, I went back in the Currensee trading records to that same starting point and calculated the percentage of profitable accounts for each quarter for members of the social network using the same methodology.

Here is the comparison of results quarter-by-quarter:

You will immediately notice that the Currensee members beat the CFTC required figures not just on average, but in each quarter as well. In fact, it’s only close on a couple of occasions. And in case there is any question as to whether these differences are meaningful, I ran a test of significance. For the statistically oriented, the T-Test of the comparison of means came through with a value of 4.94, making the difference quite significant.

One interesting thing to observe in the broker-reported figures is the increase in the percentage of profitable account in the last couple of years. They are clearly higher than the ones from the first half of the period. At least part of that can be attributed to a survivorship effect whereby profitable traders keep trading and losers drop out. The general expectation would be for an influx of new accounts to offset those where trading stops, but that seemed to stop happening in Q4 of 2011. Since then the bias in the number of active accounts has been negative (though there was a big tick up in Q1 of this year) while the number of profitable accounts has held steady. And yes, there does appear to be some impact of survivorship in the Currensee figures as well, as we’d expect.

It should be noted that in looking at the Currensee figures I only used trades which were not done as part of the Trade Leaders Investment Program – in other words, non-social/copy/auto/following trades. I wanted to do that to judge the performance of members in their own right, not performance directly driven by the trading of others. The CFTC figures have so such filter, so likely do reflect the influence of social trading. If we judge social trading as likely having a generally positive impact on performance, then the CFTC figures could be expected to overstate the performance of individual traders in the general populace, making the performance of Currensee social network members even more impressive.

A question came up during the webinar last week regarding stop hunting. One of the attendees was curious about it, no doubt having heard the term bandied about among retail traders. This gets brought up on a fairly regular basis, mostly by folks who saw their stop get hit in a market that quickly reverses back in the direction of their trade (see Stop-hunting is NOT the problem some people say). Let me try to clarify things.

A definition
First, let me explain what exactly stop hunting (running) means.

Basically, what we’re talking about here is one or more market participants attempting to manipulate prices such that the market reaches a level where preset orders are believed to reside in order to trigger those orders. Notice I didn’t specifically say “stop” orders there. They could be stops or limits. It doesn’t really matter. Those attempting to hunt those orders are just looking to get them triggered for their own purposes.

Why stop hunt?
So what are those purposes?

Imagine there are a bunch of buy orders residing at 100. What is likely to happen if the market hits 100 and triggers those orders? The market will probably go higher, right? If you know (or think) those orders are there and have the ability to push the market in that direction, can you see how you might want to trip those buy orders and then sell into the subsequent market move either to take profits on a long position or to sell at a better price?

This sort of thing has been going on for many, many years. Stories have come out of the futures trading pits (and probably from stock exchange floors too) for ages. It also happens in the inter-bank market where the primary pricing of forex rates is done.

Where retail forex is concerned, stop hunting is generally talked about more in terms of brokers manipulating prices. The fact that some retail brokers act as counter-party to their customers trades (market-making or dealing desk brokers) rather than acting as middle men (ECN or Straight Pass Through brokers) is seen as incentivizing said brokers to move prices against their customers to trigger their stop loss orders so the broker can profit from customer losses.

The reality
Back in the early days of retail forex there probably were unsavory brokers who manipulated prices to their advantage, and may still be in certain corners of the globe. Things have gotten much tighter in recent years, though, so if you stick with a reputable firm you’ll be free of that sort of abuse. In fact, as much as some like to bad-mouth the new regulations put in place in the US by the NFA and CFTC, part of what they have done is to put brokers under a spotlight to ensure these sorts of things don’t happen, and are punished if they do. In fact, one forex forum member put it to the test and found no evidence of stop hunting by retail forex brokers.

In other words, if you get stopped out on a price spike, it’s not your broker stop-hunting you. They get their prices from the inter-bank market, so if there was stop hunting being done it was almost certainly happening at that level.

Stop hunting will continue to go on in the markets, but it’s not something you should worry about. If you trade for any length of time you will inevitably fall victim to an adverse price move that takes you out of a trade only to see it reverse. There are any number of things that can make that happen. Where you are concerned, it’s either bad luck or bad stop location. A lot of those who claim they were stop-hunted just placed their stop too close to the market and either don’t realize it or don’t want to take the blame for poor decision-making.

 

There was an article on Forex Magnates yesterday which brought into question the future of the US retail forex industry. The main focus of the article is the on-going debate in the wake of Dodd-Frank as to whether, and potentially in what manner, forex transactions should be forced into exchange trading. The big question has primarily to do with the swaps and forwards markets because they are the area where liabilities between and among banks exist that create the kind of domino effect that was the major issue during the recent financial crisis. That hasn't kept folks from extending the discussion to suggest that retail forex in the US could be forced on to exchanges as well.

The demise of the US retail forex industry has been declared on several occasions in recent years in the wake of the no-hedging, FIFO, and margin requirement changes implemented by the NFA and CFTC. So far, it's weathered the storm. The US brokers are now subject to considerable scrutiny, as we can see from the number of enforcement actions the regulators have made in the last couple years. If forex trading is required to go exchange-traded only, though, will that be the thing that finally kills the business?

On the one hand, forcing spot forex onto the exchanges could kill off a number of the current batch of US brokers. They would suddenly face considerable competition from futures brokers and/or stock brokers, depending on whether the forex contracts were considered securities or futures (most likely the latter). That said, several futures brokers are already in the retail forex space, so it's not like we'd lose everyone. Also, some of the bigger brokers could yet survive the change – if they want to, and don't just decide to leave the US market and focus on their overseas efforts.

And lest we thinking this just impacts the retail side of the business, consider that the same rules would apply (in theory) to banks. The inter-bank market is the main driving force in foreign exchange. If we were to go to an exchange model it would twist the knife in the gut of the forex bank dealing world that has been suffering for years thanks to the creation of the euro (reduction in the number of traded currencies) and the dramatic improvement in technology (most dealing is electronic these days). When I started in the business in the 90s, the spreads for the most active currency pairs were 10 pips and up. Volumes are up considerably since then, but we routinely see 1 pip spreads, and even narrower for the likes of EUR/USD. That's a major profitability squeeze for dealers.

That doesn't sound particularly good for the US broker and banking community, but it could be really good for the retail forex business overall. Consider the following potential benefits:

  • Single-source exchange rate pricing
  • Volume data from a centralized source
  • No opportunity for broker price manipulation

Many folks out there still look at retail forex as the Wild West of the trading world. Forcing it into an exchange-traded structure could very well open the market up to a much wider array of traders and investors. I, for one, would be very curious to see how things shook out.

All that said, this is not a cut-and-dried sort of situation. Foreign exchange is, basically by definition, a cross-national operation. That makes it VERY hard to implement any unilateral changes. It wouldn't be too good an idea to have US banks forced to do spot trades on an exchange here when not only their foreign competitors, but even their foreign offices, were trading off-exchange everywhere else. It would take a global arrangement to facilitate that sort of thing, and we're nowhere close to that happening.

That said, it could happen on the retail level. The retail forex business is largely a self-contained (and relatively small) structure with only limited interaction between it and the inter-bank market. That makes it easier to force into a new structure. But really the retail arena isn't the major focus of what the regulators are after in terms of avoiding hidden cross-liability linkages between the major financial institutions. As a result, we probably won't see anything major happen, so I'm not sweating it.

 

We’ve been keeping track of the Occupy Wall Street movement, and here’s our take on the headlines that have been occupying our eyes this past week:

A good way to shuffle in last weekend – stocks on Wall Street increased after an Oct. 14 report showing U.S. retail spending increased in September at the fastest rate in months. That good news also translated into positive outlooks for the European markets with analysts stating that fears of a debt crisis are waning, settling markets that have been volatile since August. #OccupyWallStreet continued buzzing especially as the protests reached their one-month anniversary. Despite some mediation in the U.S. last week at Zuccotti Park in Lower Manhattan, the movement has spread overseas with protestors in Tokyo and Sydney joining London and taking to the streets. While the global economy remains in question, there’s no doubt the markets have behaved in a Jekyll-and-Hyde fashion. As a result, investors are turning to alternative investments, like hedge funds, offset the uncertainties of a volatile stock market. This past week, hedge funds posted more than 3 percent for the fourth time in 2011. For investors who are braving the stock market, some financial experts recommend keeping historical perspectives, reducing margins for errors, average costs and reconsidering risk and reward consumption. In Forex news, the Commodities Futures Trading Commission released August 2011 financial data showing total U.S. Forex deposits were up $19 million.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

A question came in from an attendee of last week's PIIGS panel discussion which wasn't directly related to the topic at hand, but which is clearly something that's on forex traders' minds these days. The question was "Is there a chance Dodd-Frank bill could end retail FX in the U.S." This is something I wrote about on my own blog last week, but I'll address it here again because it's something, which clearly needs further comment.

To answer the question very directly and succinctly, there is absolutely zero chance Dodd-Frank kills US retail forex.

That direct enough? :)

This question perhaps could have legitimately been asked a year ago when the bill was passed, but to bring it up now is useless. Basically, what Dodd-Frank said in regards to retail forex in the US is that the overseeing regulatory agencies must put regulations in place within a state period of time (a year I believe) or a prohibition would be put in place. The reason this has come up recently is that an SEC ruling came out which basically said (in order to meet the Dodd-Frank deadline) that existing rules regarding retail forex trading would stay as they are for a year while the agency considered new rules.

The fact that this SEC news has caused consternation in the retail forex trading community reflects the lack of understanding of how the market is regulated in the U.S. The SEC is only responsible for "securities" firms, which basically means stock brokers and stock exchanges. That means there are only a couple of minor forex players (and would-be players) falling under SEC purview.

The CFTC is the major regulator for retail forex trading in the US. The vast majority of forex brokers serving US customers are registered with that agency. The CFTC has already put through new rules. In fact, it was in the process of doing so even before Dodd-Frank. They didn't kill the US retail forex business then, even though there were loads of voices screaming that the FIFO, no-hedging, and 50:1 leverage limitation changes would do just that. The business is alive and well and not going anywhere.

I actually think the SEC could only really have a positive impact on US retail forex trading. The worst the agency could do is ban it for securities firms all together, but that's not something that's going to have any real impact on the industry because of the small footprint of stock brokers. If the SEC went the other way, though, and put the stock brokers in some kind of favorable position relative to the CTFC-regulated firms (or at least didn't put them in a disadvantaged position) it could actually create more positive competition in the industry.

Over the weekend the LA Times became the next major news outlook to tackle the forex market with a story titled Foreign currency trading is easy — an easy way to lose money. This one isn't quite so inflammatory as others I've blogged about in recent weeks, and I found the 615,000 estimate for American forex traders interesting. Maybe journalists are starting to get a better handle on things. That doesn't mean this particular article isn't without its issues, however.

Taking on forex marketing
I give the LA Times full marks for taking on the subject of marketing in the retail foreign exchange trading arena. In fact, I wish they would have gone a bit further with that topic. It is absolutely true that "easy" is often featured in the ads run by major forex brokers, leading the unaware to believe that they can just open an account and be on their way to riches or supplemental income.

The example provided in the article of a woman who got sucked in by this sort of marketing is an apt one. It offers us a couple of important lessons. Obviously, the first one is trading isn't as easy as some would lead you to believe. Certainly, it's easy to place trades and all that, but no one with any experience at all will call the path to successful trading a walk in the park. The second lesson is that new traders shouldn't open accounts with borrowed money (credit card charge in this case).

Betting money you don't have
Here's where things start going off the rails. The article describes trading on leverage as allowing traders to "bet money they don't have". This verbiage suggests a misunderstanding of how things operate in retail forex trading. It suggests a model like the one in the stock market where leveraged trading means borrowing to buy more shares than one could otherwise purchase. This simply isn't the case in forex. There's no borrowing to buy or sell anything.

The margin requirement in forex is a surety against loss. It effectively limits the amount of money a trader can lose on a single position, especially since most brokers these days have automatic closures that kick in when losses are too big. On top of that, many brokers indemnify customers against losing more than what's in their account on the off chance that some incredibly dramatic event causes a big gap move. Stock and futures brokers don't generally have these kinds of protections.

In other words, in forex the chances of you having money beyond what is in your account at risk are very, very, very small, if not non-existent. Traders who lose all their money don't generally do so because of one bad market move. They do it because of a series of poor trades.

Blaming it on the broker
The next step in the article is to focus blame on the brokers. We've all heard traders complain about their brokers. Most of the time it's sour grapes from someone who is looking to place the blame for their losses on someone other than themselves. The fact that the woman in the LA Times article said "They always had tricks to take my money" in talking about her broker lowers her credibility with me.

Yes. There absolutely are scammers out there. Anything popular in the way forex has become is going to attract an unsavory element. There's a steady stream of CFTC action against forex operations you've likely never heard of before. That latter part is the thing I'd focus on, though. It's not the big brokerage houses the regulators are constantly nailing for taking people's money. Certainly, there have been some issues with some of them, as the article notes, but the increased scrutiny they are under now is making for an increasingly fair market.

As for the higher turnover experienced by the forex brokers, I'll refer back to the marketing methods. Folks with unrealistic expectations don't tend to stick around long.

Brokers making money off their customers
Do forex brokers profit off their customers? You bet. Because these dealers make money on the spread, every time a customer buys at the offer price and sells at the bid they make a small profit. As I documented in my Cost of Trading post, however, the trader expenses for forex are competitive with those of other markets.

The LA Times article indicates that Gain (forex.com) made an average of $2913 per active trader customer in 2010 and FXCM made $2641. It then goes on to compare that against average customer account sizes of $3000 and $3658 respectively. I have three problems with this side-by-side analysis presumably to make us horrified at how greedy the brokers are and how they systematically bleed customers dry.

First, notice how the article uses the term "active trader" when looking at how much Gain and FXCM made, but only uses "average customer" to describe account size. That suggests to me looking at separate data sets which may not, in fact, be comparable.

Second, do we have specifics for how those revenues were made? Was that spread income. Was it carry interest? Was it something else?

Third, without having much more information about the distribution of the data for the average income and account size figures above, we really cannot make any judgments. The income figures could be seriously skewed by very active traders with large accounts while the account size figures could be weighed down by numerous inactive small accounts.

Also, the article tosses out the statistics that about 70% to 80% of Gain and FXCM customers lose money on a quarterly basis. That certainly sounds horrible, but do we have a comparison with other markets like stocks?

If you really want to see if the brokers are up to no good, figure out what they should be making based on transaction volumes and average spreads and compare that to what's being reported. If there's a big gap, then an explanation will be wanting.

This is the first week under the new CFTC rules restricting leverage for holders of US retail forex trading accounts to 50:1 for the major trading pairs and 20:1 for minor ones (see Asaf's post and an earlier one of mine on the subject). Obviously, there are implications for certain traders because of the change (probably not the vast majority, though), but one of the more interesting aspects of it all is the reporting the brokers must now do regarding the performance of their brokerage customers. They now have to disclose to new account holders the % of customers who have made and lost money. Forex Magnates has gotten hold of these reports for most of the brokers servicing the US customer base and presented the information from them here.

Profitability

The common mantra in retail forex trading is that 95% of all traders fail. Of course we don't really know what "fail" means or over what timeframe this is meant to cover. The figures from the brokers are equally subject to some "Yeah, but" type questioning. According to the Q3 figures, about 25% of brokerage customers are profitable, if you don't include Oanda.

The problem we have here is that we really don't know what these numbers mean in terms of long-run trader profitability. The % profitable figure is very likely to demonstrate a survivor bias whereby traders who crash and burn will eventually fall out of the study, as the reporting only includes accounts where trades have actually been made. Obviously, if you've lost all your money or become so disheartened by poor performance that you stop trading all together, you're not going to be counted.

Then we have the question of Oanda, which shows WAY better customer profitability than the others. Are they using a different calculation methodology? Does the fact that they pay interest on your margin balance influence the reporting? I ask because an account that does no trades but still has a balance will end the quarter profitable because of the interest earned. I don't know if those daily interest payments are transactions which make an account "active" or not. I'd love to hear from someone at Oanda whether that's the case. If not, then we have a very significant question as to what makes Oanda customers more profitable. Is it somehow a function of the 50:1 leverage they've always had? If so, it starts to make the CFTC decision look a lot better.

The demise of US retail forex trading

The other thing we can look at in these reports is the actual number of active customer accounts each broker has. Folks have been howling about the pending destruction of the US forex business every since the NFA came through with its FIFO and no-hedging rules last year. The broker reports don't go back that far, so we can't see what impact was had where folks shipping their accounts overseas might have had, but since many of those accounts are now coming back, and will thus be included in the broker Q4 numbers we may get some idea.

We can perhaps get an idea what the CFTC leverage restrictions may have done to US broker accounts, though. The initial proposal of a 10:1 leverage limit hit the markets at the start of this year, with the announcement of the final 50:1 cap coming in August. The table below outlines the impact.

Notice that in the first quarter of the year there was a 5% reduction in active broker accounts. Thereafter, though, the decline has only been 1% in each of the last two quarters. I'm reluctant to call that any kind of major problem, and it will be very interesting to see if the forced-repatriation of accounts from foreign lands that is happening will actually result in a positive impact on the numbers for this quarter, especially for those brokers who have had the biggest drop in US accounts.

Again, we see Oanda as a major outlier. Rather than being about flat to lower in terms of customer accounts, it has seen a 20% rise in the last year. Considering Oanda does not do any marketing and has only every allowed a maximum 50:1 leverage, these are quite interesting figures. It leaves one to wonder if that reflects the fact that Oanda has no fixed lots, and thus allows very low capitalization customers to take part in the market without having to trade with very high leverage ratios. That's just speculation at this point, though. We may never really know.

The point is that we probably haven't seen the end for the US forex business, despite the doomsayers. We'll want to wait to see the Q4 2010 figures for a better reading on customer accounts, though, because of those who would have moved accounts offshore away from CFTC oversight and those brought back from broker foreign affiliates.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results.

4 Comments

There has been a lot of chatter in forums and blog posts by some well-respected people in this industry about the final ruling of the CFTC regarding forex trading for US residents, and I’d like to express my opinion on the matter.

It seems like the leverage restriction has become less of an issue for traders, especially after Japan has already decided to restrict leveraged trading in FX with similar restrictions.

So we’re left with mainly two restrictions that traders for some reason feel limit their ability to trade or make more money than they already make. The restrictions are the good old “FIFO rule” and “No Hedging” rule, which have been in place for US traders for some time now.

A little explanation of these rules and what they mean (or don’t mean) in reality:

The FIFO rule indicates that positions that were opened on a certain instrument (currency pair) have to be closed in the same order. This means that if I open a 1 Lot position on the EUR/USD and an hour later open another 1 Lot position on the EUR/USD, when I want to close a position I have to close the position that was opened first before I close the second position. The perception of traders is that it’s possible that the first position is losing money and the second position opened later is making money. Therefore, if I close my first position I would be booking a loss, whereas if I close only the second position I would be booking a profit and I can keep my eyes closed and say a prayer hoping for the other position to turn around, booking profit there as well. The reality is that it absolutely doesn’t matter which position you close first to the overall P&L, and closing the losing position first and letting the second one run for additional profit is going to get exactly the same result.

The second restriction is the "No Hedging” rule, which means that a trade cannot hold opposing positions on the same instrument at the same time. The rule is a little more forgiving than this, but in reality this is how it’s implemented in most brokers. Some traders are under the impression that they can open a LONG position and then if it goes south open a SHORT position that would balance out the LONG position. In reality opening a SHORT position though enabling the trader to keep his eyes closed and not realize losses on the LONG position is exactly the same as closing the original LONG position and realizing the losses and it doesn’t really matter what the market is going to do next.

So to sum this up, there is no way in the world that hedging and non-FIFO would have any affect (positive or negative) on the ability of a trader to succeed or limit the profitability of a trader – so stop complaining :)

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

This week the New York County Lawyer's Association (NYCLA) hand-delivered a 5-page letter to the CFTC detailing their comments to the controversial proposed rulings. Gotta love it when the lawyer-types get in on the action.

The two main rules they are opposing are

  • Proposed rule 5.9 regarding 10:1 leverage because it could have a significant and negative impact on the retail Forex industry
  • Proposed rule 1.10 regarding guaranteed IBs on the ground that it is anti-competitive and places and undue burden on Forex IBs

We couldn't agree more, especially as it relates to the guaranteed IB ruling 1.10. Their letter states the case brilliantly.

Although the Commission's rationale is compelling, there appears to be an inconsistency between the Commission's purported goal and the means by which it proposes to achieve this goal. The Rules effecitvely create two classes of IBs - those who introduce off-exchange retail Fore customers to counterparties ("Fore IBs") and those who introduce customers who trade exchange-traded futures contracts to counterparties ("Futures IBs") - and subjects these classes to differential treatment.

The letter goes on to address the Commission's objective for the Proposed Rule 1.10 - to reduce fraud in the marketplace.

There appears to be no clear correlation between a reduction in incidents of fraud and the requirement that Forex IBs be guaranteed. In fact, mandating the registration of Forex IBs alone could suffice in in meeting the Commission's stated objective. As the NFA has bulicly acknowledged, the buld of enforcement activity occurs amongst unregistered industry participants.

In the letter we submitted to the CFTC, we take the IB ruling one step further as it affects customer choice.

If adopted, the guarantee requirement will interfere with the legitimate activities of many Forex IBs, including those signing this comment letter, which have introducing relationships with multiple forex dealers. We fail to see how customer protection interests are served by denying customers access to Forex IBs that help them make informed decisions about where to trade Forex or by creating circumstances under which every Forex IB will face an inherent conflict of interest between representing the best interests of its customers and the commercial interests of the dealer on which it must rely exclusively for its business survival.

If passed, these rulings will affect the way you trade, the way you are handled as a customer and the choices you have as a trader. The CFTC will make their decisions based on how they think it will impact you. The comment period has ended and they are deliberating in a chamber somewhere. Let's hope that all of the efforts to help the CFTC see the negative impact of the regulations on traders like you and I are heard loud and clear.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.