How Much Leverage Should a Broker Provide
August 1, 2018
Forex trading is based on leverage, as this is the only way a retail trader can access the interbank market. In other words, for every dollar in a trading account, the trader can move a bigger amount.
Forex brokerages offer various levels of leverage to their retail clients, starting from 50:1 and going all the way up to 3000:1. This means that the amount the trader is moving is up to 50 or 3000 times the amount in the trading account.
Needless to say, the bigger the leverage, the bigger the risk taken as small swings are enough to wipe a trading account. However, retail traders are inclined to take bigger risks and always favor a bigger leverage.
Why Using Leverage?
The idea of leveraging is not new to the investment community, as both investors and companies are using leverage. For example, companies use leverage to finance assets in order to increase shareholders value. Investors, on the other hand, use leverage to increase the potential return.
The same is valid for the Forex industry, as a higher leverage will, in theory, offer a greater return. As mentioned above, the risk grows exponentially.
When compared with other industries, the leverage offered in the Forex market is one of the highest that can be obtained. If you want, a leverage is a loan from the broker to the retail client.
The downside of using too much leverage is that if the market happens to go against a trader’s positioning, by the time the broker gives a margin call, there is nothing left in the trading account.
On the other hand, if proper leverage was used, even if a margin call is given, there is still something left to start trading again. In a way, managing leverage is managing risk and traders who fail at money management, fail in trading.
How Much is too Much?
Usually, the amount of leverage provided by a broker is 50:1, 100:1, 200:1 and 400:1. Out of the four options, the last one is the most popular among retail traders.
To avoid having retail traders exposed to too much risk, the U.S. regulators limited leverage to 50:1, still a large amount, though. This limitation is still in place for all U.S. based traders.
In the end, it is not always up to the actual trader what the leverage will be used. It is more of what the leverage the Forex broker is offering for a specific type of trading account.
The recent SNB (Swiss National Bank) decision to end the EURCHF peg to the 1.20 level caused a lot of pain for high-leveraged traders and this made regulators turn their attention to leverage. The idea of a leverage cap like in the United States is being discussed in Europe and Australia, but also in other parts of the world, as leverage is an important thing to consider before starting trading the Forex market.