Leverage is the tool that transforms foreign exchange trading from an internal game of commercial and central banks into a business accessible to the widest range of private individuals. Thanks to the interest-free loan provided by the broker, traders’ positions are brought up to the required minimum and placed on the market, while the broker earns spreads and SWAP as payment for its services. Therefore, discussions about the benefits of leverage seem unnecessary.
It is also known that margin trading carries both advantages and risks, and traders often lose their deposits because they use too much borrowed capital. However, the loan provided, regardless of the trade result, always returns to the broker, so the company, unlike its client, loses nothing. However, representatives of the brokerage business somehow do not fully apply this tool and limit the maximum leverage. How can leverage harm not only the receiving but also the providing side? This will be discussed further.
Leverage on Forex: The Question of Size
Let us recall how leverage works on the currency market. To satisfy a trader’s request to open a trading position, the broker adds the amount needed to reach the minimum contract size to the trader’s funds. The ratio of borrowed and own funds is called leverage.
Thus, the higher the leverage on a position, the larger the total volume of trades that can be opened, and the higher the broker’s profit from the client’s trading.
Following this logic, a brokerage company should be directly interested in offering clients the maximum possible leverage and motivating traders to take as much borrowed capital as possible for each trade.
However, most honest forex brokers offer leverage of 1:50, 1:100, 1:200, or at most 1:500, consciously limiting their own profits. There are several reasons for this:
- The company cannot influence the activities of its clients or change the nature of margin trading. However, the broker aims to minimize the losses of traders as much as possible, preventing trades that could trigger a Margin Call. Because every lost deposit is a lost client for the company.
- It is no secret that traders tend to blame others for their failures in the market, so a reputable company, wanting to prevent potential reputational damage, protects inexperienced beginners from making high-risk large-volume trades.
- Traders using leverage do not receive the borrowed funds “in hand” and do not perceive them as a real loan. Nevertheless, to place a position on the market, the broker must invest its own money. Therefore, if the company does not intend to cover orders internally, it must reasonably assess its financial strength and accept only those credit obligations it can fulfill.
Thus, in the long run, offering traders leverage up to 1:500 is more profitable for the brokerage business than attracting clients with leverage of 1:1000 or higher.
Of course, this does not mean that a company offering high leverage is necessarily against its clients, but the maximum leverage size can and should be one of the factors considered when determining the integrity of the company.
Size of Leverage – Indicator of a Honest Broker
Before deciding to open a trading account with a company offering leverage of 1:1000 and above, make sure that:
- This offer is indeed not for all clients, but is selective: only for owners of certain types of accounts, trading specific instruments, etc.
- The company has sufficient capital to ensure the placement of a large number of client orders on the market considering the high leverage.
- The broker warns clients about the dangers of margin trading and especially about the risk that increases when trading with a high ratio of own and borrowed funds.
Thus, by objectively considering leverage, not only from the perspective of its usefulness to you personally, but also as a tool for the brokerage business, you can make more balanced and ultimately more beneficial decisions in the market, both when opening a trading account and when executing each specific trade.
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FAQ
What is leverage in forex trading?
Leverage allows traders to control larger positions with a smaller amount of capital, increasing both potential profits and risks.
Why do forex brokers limit leverage?
Brokers limit leverage to protect clients from excessive risk and to manage their own financial exposure, ensuring they can meet their obligations.
Can high leverage harm a broker?
Yes, high leverage can increase the risk of significant losses for the broker, especially if clients suffer large drawdowns, which can impact the broker’s stability and reputation.
