The Swiss Franc Shock is the global upheaval in the foreign exchange market caused by the Swiss National Bank’s (Central Bank) policy change on January 15, 2015.
In this article, we will discuss the “fear and horror” of the Swiss franc shock, which all seasoned forex traders are familiar with, focusing on the “actual trades” that led to it being triggered.
By reading this article, you will see one of the must-lose trades to avoid, and you will realize that the adage “anything can happen in the market” is true.
- The events leading up to the Swiss franc shock
- What are the characteristics of currency intervention by the Swiss Central Bank?
- Intervention by the Swiss Central Bank in the Swiss franc exchange rate
- Aside – Allegations of insider trading at the start of currency intervention
- Swiss Franc Shock – Summary
The events leading up to the Swiss franc shock
In 2011, European countries were suffering from a debt crisis triggered by Greece’s financial problems. This is called the “Euro crisis (European debt crisis).
Switzerland, which uses its own currency, the Swiss franc, was also affected, and concerns about economic deterioration and deflation began to emerge.
In the foreign exchange market, the “selling of euros and buying of Swiss francs” became more and more intense against the backdrop of these concerns, and the trend of the appreciation of the Swiss franc did not stop.
Since the Swiss franc has value as a safe-haven or refuge currency, the strong anxiety over the euro attracted buying of Swiss francs.
The Swiss National Bank, feeling threatened by this rapid price movement, declared on September 6, 2011 that it would not allow the Swiss franc rate to rise above a certain level, and launched a hard-line foreign exchange intervention program of “unlimited selling of Swiss francs” in the foreign exchange market.
What are the characteristics of currency intervention by the Swiss Central Bank?
To understand the enormity of this “unlimited Swiss franc selling” currency intervention, let us review a little about currency intervention here.
Please refer to the article below for a more detailed explanation of the basics of currency intervention.
Explanation 『為替介入』とは？分かりやすくチャートで見る「世界の為替介入」
There are two types of foreign exchange intervention: “buying” and “selling” intervention. In order to intervene in the “buying” method, funds (foreign currency) are needed to buy the home country’s currency.
For example, if the Japanese yen becomes too weak to intervene to buy the yen, funds to buy the yen – in other words, the U.S. dollar and other currencies – are required (this is called foreign exchange reserves).
If the U.S. dollar, which is the fund for yen-buying intervention, is used up, the country will find itself in a situation where it can no longer intervene even if it wanted to.
Intervention in the currency market to sell its own currency can (theoretically) be unlimited
What about “selling yen to intervene”?
Selling Yen to intervene” means that the BOJ (Bank of Japan) exchanges its Yen for US dollars in the foreign exchange market.
Therefore, theoretically, the BOJ could intervene in an unlimited number of yen sales if it prints enough banknotes.
This is how the Swiss central bank intervened, selling Swiss francs to prevent them from appreciating beyond a certain level.
This continuous “unlimited intervention” eventually caused a major upheaval in the foreign exchange market, leading to the controversial “Swiss franc shock”.
Intervention by the Swiss Central Bank in the Swiss franc exchange rate
Let’s take a look at the actual currency intervention by the Swiss Central Bank against the Swiss franc at that time, using a chart.
The chart above is a weekly chart of EUR/CHF. The light blue line is the “rate at which the Swiss Central Bank will never let it fall any lower”.
In order to keep the EUR/CHF below 1.2000 (i.e., to keep the Swiss franc from appreciating), the Swiss Central Bank sold the Swiss franc incessantly.
The intervention lasted more than three years, from September 2011 to January 15, 2015.
During this three-year period, the Swiss Central Bank intervened to push the euro/CHF exchange rate up when it approached 1.2000, and then slowly and steadily pushed it back down when it approached 1.2000, repeating this process over and over again.
Completion of the “Holy Grail market” of an ironclad range market
- It will never go below 1.2000.
- Because the Swiss government has an unlimited supply of Swiss francs to sell.
This market consensus resulted in a range that the Swiss franc market would never break below.
From then on, a large number of buy orders were gathered against the 1.2000 level.
This was because market participants knew that as long as they kept buying until the 1.2000 level, the Swiss central bank would eventually intervene and the rate would return to its previous level.
As shown in the figure, a range trade was made by repeatedly buying averaging down with the Swiss Central Bank’s intervention line, 1.2000, as a backdrop, and taking profits as soon as the price reached a certain positive level.
This is a trading method that should be called the “Holy Grail” in another sense. It is, after all, “averaging down method where you never have to cut your losses.
Please take a look at the chart of the Euro/Swiss Franc at that time when it was in a range.
Even if there is no intervention and the exchange rate continues to level off, if you keep averaging down, the average acquisition price will get as close to the current rate as possible.
If the rate starts to rise even a little, you will be able to make a profit, and if there is an intervention by the Swiss Central Bank, you will make a lot of money.
There was a dangerous trap waiting there, wide open
But look at the chart closely.
You will see that although it is in a range, it is still falling slowly and steadily.
In other words, we can see a very weak but long-term downtrend.
So…
- It’s bound to go up someday, so I’ll just keep buying!
- I’m sure it’s going to go up one day. It doesn’t seem to be going up very much. …… I wonder if they will intervene soon. ……
- But it’s bound to go up, so let’s buy more while we still can.
The market will accumulate more and more buying positions like this. These buying positions would then trigger the subsequent Swiss franc shock and become a “powder keg.
In the end, in this range, we believe that a terrible situation was occurring, where there was a “large amount of nanpin (averaging down) buying positions” with unrealized losses, unable to lock in profits, and just waiting for the market to rise.
This is a must-lose trade, called “against-the-trend nanpinning.
Please refer to the article below for an explanation of the nanpinning technique and its risks.
Explanation What is Forex averaging down? How to understand it and trade tactically
This (false) Holy Grail method is only possible with the “unlimited intervention” of the Swiss Central Bank. In reality, however, the rate did not move so well, and the “buy-and-hold” positions with unrealized losses only accumulated.
The tragedy began when the Swiss Central Bank suddenly announced that it would lift the ceiling on the exchange rate against the euro (no more intervention).
The bottom of the range has finally fallen out with the removal of currency intervention by the Swiss Central Bank!
January 15, 2015, 10:30 AM local time. The world was hit with the news that “the Swiss Central Bank will stop intervening in currency markets.”
As you can see from the chart, in just a short time, the euro/CHF dropped by up to 40% (the Swiss franc surged against the euro).
This was truly a strong shock that should be called the “Swiss franc shock.
In Japanese yen terms, this is the same impact as when the yen was 100 yen to the dollar and the next moment it was 60 yen to the dollar.
As of this writing in July 2018, the dollar is hovering around 110 yen.
What would happen if this suddenly dropped below 70 yen? The magnitude of the impact is hard to imagine, as the yen would easily appreciate to a level that exceeds the historical rate after the Great East Japan Earthquake.
In fact, Switzerland is said to have fallen into a near-recession as a result of the sharp appreciation of its currency, with the tourism industry taking a major hit.
The subsequent rise in domestic prices has had a long-lasting impact, as everyday consumption has been shifted abroad one after another.
As far as FX is concerned, the collapse of a major overseas FX firm (Alpari) and massive losses by individual investors made headlines, and for a while afterwards, many people said “FX is dangerous! and many people have been saying, “Forex is dangerous!
And above all, it was yet another example of how “anything can happen in the market”.
The article in the reference link below reports on the Swiss economy after the Swiss franc shock.
Reference Swiss economy slowly recovering from exchange rate shock｜swissinfo.ch
The video below shows a local report by the BBC (British Broadcasting Corporation) immediately after the Swiss franc shock.
Aside – Allegations of insider trading at the start of currency intervention
In August 2011, three weeks before the Swiss Central Bank’s currency intervention, there were allegations that some insider trading had taken place.
The allegation is that Kashua, the wife of the then central bank governor Hildebrand, obtained information on the Swiss Central Bank’s intervention in advance and bought dollars based on that information.
The governor’s wife, Kashua, is said to have profited greatly from the depreciation of the franc after the intervention (60,000 francs, or about $64,000 at the then exchange rate), and this was called into question as “insider trading by a bank official.
The allegations were discovered in November of the same year, and Mrs. Kashua explained that the dollar was at an all-time low and was ridiculously cheap, and that she had 15 years of experience in the financial industry and therefore always kept a close eye on market conditions.
As a result, the investigation found no irregularities that violated internal regulations, and the insider trading charges were dropped, but her husband, President Hildebrand, was forced to resign in January 2012.
Personally, I can understand Mrs. Kashua’s point to some extent, but as the saying goes, “Never judge a man by his name,” and it is obvious that anyone would suspect a leak of information, I must say that she was too lenient in her position.
Incidentally, the information on Mrs. Kashua’s transactions that led to the allegations was brought to us by a Sarasin Bank Switzerland employee in charge of the IT department. The employee was later fired for his role in the leak.
Swiss Franc Shock – Summary
The Swiss franc shock refers to the global upheaval, especially in the foreign exchange market, caused by the “unrestricted Swiss franc selling intervention” initiated by the Swiss National Bank (central bank) in 2011 and the subsequent removal of its currency intervention policy.
The Swiss franc shock literally brought various shocks to the world.
During the period of intervention, a “false holy grail” market, a “range that never falls below the intervention rate,” was realized, and a large number of “buy euro/CHF positions” were accumulated against the backdrop of the intervention rate. There were also many reckless “buy-and-hold” positions.
The Swiss central bank’s announcement that it would no longer intervene in the market caused the bottom of the range to fall out, and the market fluctuated so sharply that it was unprecedented in history, wreaking havoc on the foreign exchange market.
This is a clear example of how anything can happen in the market and how it is essential to manage risk based on this premise.
In this article, we have explained the “Swiss Franc Shock” and told you about the traders who have indulged in the false Holy Grail method.
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