What do Forex brokers hide about leverage?
What do Forex brokers hide about leverage?
The rapid development and popularity of Forex trading has been made possible by several factors. If earlier exchange trading and foreign exchange operations were available only to a small circle of businessmen, now it is available to almost everyone. Technological progress, the spread of the Internet, the information revolution and globalization have played an important role. But the main reason for the availability of foreign exchange trading was the leverage provided by Forex brokers.
The principle of margin speculative trading
The concept of margin trading has been known for a long time. On various exchanges, commodity and stock exchanges, some part of the transactions was always speculative. Stock speculators bought goods or stocks cheaply in order to sell them later at a profit. A commodity or stock cannot depreciate to zero, so the speculator only risks the amount of the price difference. Stock brokers provided loans to such traders, requiring only a fraction of the value of the goods as collateral (margin). Thus, the speculator can earn income from the full value of the product, having only a fraction of the money needed to buy it.
The same principle is used in modern Forex trading. Most of the participants in this market enter into transactions for the exchange of currencies necessary to support international trade and other payments. These transactions form exchange rates based on supply and demand. Currency traders strive to get income on changes in exchange rates. Moreover, this is done not only by individuals, but also by banks, various funds and financial companies. And if for a large financial organization the minimum transaction amount of 100 thousand dollars is not a problem, for most private traders it is a lot.
For them, the foreign exchange market becomes available using the principle of margin trading. The merchant is obliged to have in his account an amount sufficient to cover the amount of possible loss – margin requirement. This amount is usually determined as a percentage of the contract volume. The standard in the Forex market is 1%, but it can change up or down. Forex brokers with maximum leverage require only 0.1-0.5%. In the rules of margin trading, financial leverage is often written as a proportion of the amount of the collateral to the volume of the transaction. A 1% margin requirement is referred to as a 1: 100 leverage. In this case, the trader enters into a deal with a volume of 100 times more than the amount of his deposit. Reviews about the STForex broker mention a leverage of 1: 1000.
Advantages and Disadvantages of Leverage
The use of leverage in the Forex market by private traders increases their income opportunities. According to statistics, the average deposit of a client of Russian Forex brokers is $ 1,000. With such a deposit, a trader can operate at least one standard lot. This means that 100 points of profit will double his capital. This is with a leverage of 1: 100, and brokerage companies offer a much higher ratio. A trader can choose anyone according to his capabilities, style and trading strategy.
But leverage in Forex is a double-edged sword. Increasing the likelihood of earning higher returns also implies a higher degree of risk. Trading on margin cannot be considered just a form of income. This is one of the types of business, and any business is always at risk by its nature. Lack of information, ignorance of pricing rules, and many other factors can lead to an incorrect assessment of the situation and losses. And with leverage, losses multiply.
For professional traders, leverage is irrelevant. The beginner is tempted to use all his possibilities. Incorrectly calculating the volume of the position, such a trader risks losing the whole deposit, since the broker forcibly closes the transactions when the margin volume is insufficient to ensure it. Therefore, government regulators limit the acceptable leverage ratio. European regulators even require clients to test their understanding of the risk of margin trading. And companies licensed by the Central Bank of the Russian Federation included in the new 2018 Forex broker rating in Russia can provide a leverage of no more than 1:50.
Forex brokers’ interest in leverage
Forex brokers are targeted at clients who engage in speculative trading. Such transactions do not always require a real delivery of currency. Moreover, not all transactions are brought to the interbank market. If, for example, the company’s clients bought 40% of the volume of dollars for the euro, and sold 60%, then the aggregate position of 20% is opened with a dealer or market maker. The broker receives a payment for each trade, the amount of which depends on the volume of the position. The payment is set as the difference between the purchase price and the sale price (spread). For example, HYCM Forex broker has set a minimum spread of 2 pips.
With a standard lot of 100,000 currency units, one pip is $ 10. By providing leverage, the broker allows a trader with a capital of $ 1000 to open a position in a full lot and immediately receives $ 20 of profit, regardless of the result of the transaction. In fact, the brokerage company does not give any credit to its clients. Traders are given the opportunity to control large amounts of capital using a small part of it. Thus, the profit of a Forex broker increases many times over.
Often, a brokerage company does not need the entire amount of capital to execute client orders. As already mentioned, only the aggregate position is displayed on the interbank market, which is executed by a prime broker or market maker also with leverage. However, in the interbank market, the leverage is much less and ranges from 1: 2 to 1:10. In any case, margin trading is a source of profit for Forex brokers.