Leverage & Multi-Day Positions

[cascot]

Most, if not all, of the broker accounts aimed at the retail market offer leverage, normally in the 100:1 to 400:1 range.

If you open a $400k position (400:1 leverage) and leave it open for seven days, how is the $399k required to pay for the contracts being funded, given that the spread for the broker is often just 3 pips. Borrowing $399k for a week likely costs in the region of $300 - $400, so clearly leverage in the Forex market cannot be working like that.

My guess is because none of the $399k is actually ever at risk (only the 1k put up by you) and it's only the end of day net (settlement) figure that matters? The broker then rolls the position over, debit or credits your account with the appropriate amount and the whole process starts over again? Effectively the broker benefits from their credit rating in the market and passes that advantage on to you.

Anyway, an explanation of how it REALLY works would be much appreciated.

Thanks.

 

[Jack o'Clubs]

Check with your broker how they apply financing as they differ, but most will apply the interest rate differential to your position (maybe plus or minus an 'adjustment' which will go into the broker's pocket). If you trade a currency pair, you're effectively going long one currency and short another. The short position will earn credit interest, the long position charged debit interest. If the interest rate in the country you're long is lower than the one you're short of you may end up with cash being credited to your account, rather than interest charged.

 

[cascot]

Jack o'clubs,

Thanks for your reply.

I don't yet have a broker as I'm only researching the market at this stage, but of the brokers I have considered as possibilities I found the following on fxcm.com

"At 5:00 PM New York Time, funds are subtracted or added to accounts with open positions because of the automatic rollover. For accounts that have a margin requirement of two percent or more, funds are added to the account for positions in which the client is long (holding) the currency bearing the higher interest rate. Funds are deducted in the opposite circumstance. For accounts that do not have a two percent margin requirement, the rollover amount is deducted from the account for each position regardless of the account's holdings."

There's just something that doesn't seem right. If I never carry an overnight position, I have read nothing about any kind of charges related to the use of the brokers margin facility, so they are apparently willing to, for example, provide me the benefit** of 399k of leveraged trading capital when all they will make is the 3 pip spread??

** OK, so benefit is almost a tongue-in-cheek description, I mean can we really refer to access to 400:1 leverage as a benefit?? I wonder how many traders with multiple years of success behind them make use, or ever did make use, of 400:1 leverage, or even 100:1 leverage?

Can someone enlighten a rookie as to why this kind of leverage is being made available for, apparently, no cost? I'm clearly missing something somewhere.

 

[Doctor Leo]

Such high leverages were introduced only for to persuade lots of people with 10 bucks to lose these 10 bucks at the bucketshop which offers a 400:1 leverage. Nothing else. Any serious trading starts with at most 50:1 leverage and at least $10,000 of deposit.

In fact, it doesn't matter what exactly the leverage is as long as you have pre-defined stop levels. This means that you will not lose more than you can afford according to your MM. In this case at some brokers you can even open a position with huge leverage, say, if you use a 5-pip stop you can open a position of $200,000 with just $100 on your account. Of course, the risk here is far beyond any reasonable limit. But in case you open a position of $10,000 with a stop of 100 pips the ratio of the opened position to the sum at risk is the same 100:1. That's what is called "leverage" in fact.

As to 200:1, 400:1 and 1000000:1 leverages please remember that they are introduced only to help people come apart with their money, and the sooner, the better. Myself, I wouldn't ever trade at a broker who offers such a leverage, it seems to me that it's more of a bucketshop than of a broker. So, don't look for market swaps with such "leverages", I wouldn't expect any reasonable order handling and execution, too.

 

[cascot]

Doctor Leo,

Such high leverages were introduced only for to persuade lots of people with 10 bucks to lose these 10 bucks at the bucketshop which offers a 400:1 leverage. Nothing else. Any serious trading starts with at most 50:1 leverage and at least $10,000 of deposit.

As to 200:1, 400:1 and 1000000:1 leverages please remember that they are introduced only to help people come apart with their money, and the sooner, the better.

I agree with you about serious trading, at least in terms of leverage range, however why would it be advantageous form a brokers perspective for it's clients to lose money let alone "..the sooner, the better"? I agree the use of such leverage levels will certainly aid a trader on the path to losing their money (and fast), but why would it be in the brokers interest for that to happen? The more clients they have who actively trade the more positions they open and close, hence the more times they benefit from the spread.

You seem to be suggesting that such brokers are not even putting orders into the market, but instead taking the risk themselves just like a bucketshop or bookmaker, in which case it's certainly beneficial to them if you lose.

 

[martin brown]

Doctor Leo,



I agree with you about serious trading, at least in terms of leverage range, however why would it be advantageous form a brokers perspective for it's clients to lose money let alone "..the sooner, the better"? I agree the use of such leverage levels will certainly aid a trader on the path to losing their money (and fast), but why would it be in the brokers interest for that to happen? The more clients they have who actively trade the more positions they open and close, hence the more times they benefit from the spread.

You seem to be suggesting that such brokers are not even putting orders into the market, but instead taking the risk themselves just like a bucketshop or bookmaker, in which case it's certainly beneficial to them if you lose.

that is exactly what is going on. 95% of so called "fx brokers" do NOT offer direct market access.

any "broker" that does not offer DMA is infact not a "broker" at all.

 

[Doctor Leo]

Cascot,

a little cold water onto your head Do you know the minimum amount to appear in, say, Reuters or Bloomberg, or any other Interbank informational system? I'm afraid I should disappoint you - 1 million base currency (euro, cable, dollar...). So all those traders with $100 depos are less than nothing to Interbank. That's why it's simply impossible to put such a small amout onto the real market, and of course all those 'brokers' do not do it.

The difference lies in the way these shops behave behind the scenes. Some of them simply calculate the summarized position of all its customers and hedge it on Interbank. But there are some (and, to be honest, quite a few) shops which do not do it: some think it's not necessary because 98% of its customers lose money, some simply do not have enough clients with enough depos to hedge a summarized position. Thus, in case of a strong market movement and, say, 50 per cent of customers having open positions to the positive direction a shop of the first type will simply hedge the position and will pay its clients. The shop of the second type is likely to go bankrupt. Now, it's up to you to decide with whom to work.