Leverage and the great Retail Forex Scam
FINRA is requesting comment on a proposed rule prohibiting any member firm from permitting a customer to:
(1) initiate any forex position with a leverage ratio of greater than 1.5 to 1; and
(2) withdraw money from an open forex position that would cause the leverage ratio for such position to be greater than 1.5 to 1.
FINRA - Rules and Regulations - FINRA Manual Online
Thank you for that link Stochastic. It deserves wider explanation than so far aired.
If traders took their $10k and actually BOUGHT the hard stuff and not the electronic variety as we currently do from the over-the-counter bucket shops, I am certain the oft-quoted "90% of traders" who lose would very quickly fall to less than 30%. In fact I would submit more than 98% of retail forex traders lose.
Here is the text of the FINRA proposal - although the time has expired for submissions, it is very worthy of printing in full:
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Background and Discussion
The primary foreign currency exchange market is the interbank market, in which commercial banks, central banks, currency speculators, corporations, governments and other institutions trade currencies amongst themselves. This market is an over-the-counter (OTC), decentralized market without any trade reporting or central clearing facility.
In recent years, an electronic, secondary OTC spot contract market has developed for retail customers (retail forex).
The current retail forex regulatory environment is a by-product of the Commodity Futures Modernization Act of 2000 (CFMA)3 and the CFTC Reauthorization Act of 2008 (Reauthorization Act).4
The CFMA and the Reauthorization Act amended the Commodity Exchange Act (CEA)5 by removing some of the legal uncertainty pertaining to the Commodity Futures Trading Commission's oversight of retail forex activity by permitting only certain enumerated regulated entities to act as counterparties to a retail forex contract.
Specifically, the CEA allows futures commission merchants, retail foreign exchange dealers, financial institutions, broker-dealers and certain other entities to act as counterparty to retail forex contracts.6
Historically, retail forex activity has been concentrated in the futures commission merchant (FCM) channel. Retail forex transactions conducted through a broker-dealer are expressly precluded from CFTC oversight under the terms of the CEA.7
In general, the leverage ratios for retail forex by futures intermediaries were set to be comparable to the leverage ratios for currency futures traded on futures exchanges.
As such, retail forex contracts in the FCM channel
commonly have leverage ratios of 100 to 1 or more.
For example, if an investor wishes to purchase $1 million worth of a foreign currency offered with a 100 to 1 leverage, the investor would only need a good faith deposit of $10,000. If the investor deposits only the minimum funds required, and if the value of the foreign currency contract dropped by 1 percent (to $990,000), the account equity would be depleted entirely and the investor's position would be closed out. The investor would lose the entire $10,000 deposit.
In the retail forex market, there is neither any margin call nor any notice for an investor to deposit additional funds to maintain his or her position.
As a result, even small intra-day swings in currency rates have the potential to close out investors on either side of the market.
FINRA has observed a potential migration of retail forex activity from the FCM channel to broker-dealers.
To protect investors, FINRA proposes to limit the leverage ratio a broker-dealer can offer to a retail forex customer.
FINRA does not believe that high leverage ratios are consistent with its mandate to protect investors. In the securities industry, the initial margin requirement for marginable equity securities is 50 percent, representing a leverage ratio of 2 to 1.8
In addition, there are separate, lower maintenance margin requirements.9 Further, if the current market value of the equity in a securities account drops below the maintenance requirement, the investor would not be immediately closed out, but would receive a "margin call" and have an opportunity to deposit additional funds to keep the position open. FINRA also notes that any funds deposited to maintain a forex position or any account equity derived from a forex position may not be used to purchase securities.
Given the speculative and volatile nature of retail forex activity, FINRA believes the maximum leverage ratio for retail forex should be 1.5 to 1. FINRA also believes a firm should not permit a customer to withdraw money from an open forex position that would cause the leverage ratio for such position to be greater than 1.5 to 1.
Requiring greater initial deposits for retail forex
will substantially reduce the likelihood that any small adverse percentage change in the exchange rate of a foreign currency will cause an investor's funds to be wiped out. Moreover, limiting the leverage ratios is intended to reduce the risks of excessive speculation.
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Effectively, FINRA is saying they recognise that the availability of high leverage is the reason retail foreign exchange investors are losing money - they stopped short of coming out and and saying "ripped off" by leverage.
Sure, traders say they understand the risks of their use of leverage. But do they really?
If you asked every trader how to calculate the actual leverage he/she is utilising at any given time, I would suggest 98% would be clueless.
The maths is beyond most traders.
Some traders, granted, have actually gone into this, and I would be willing to wager, that unless the trading method is a short-term scalping method, for example, it is unlikely traders are having success. Yet if the leverage used was lower, allowing for wider stops, the probability of profitability occurring would rise parabolically in step with such decrease in leverage.
Now I can not prove this because I do not have access to the accounts of traders and their trading tactics.
But given the ease at which leverage is offered by bucket shops, it is highly unlikely leverage is used to benefit the trader. What the brokers promote as "the benefits of 200:1 leverage" is actually of benefit to THEM, not the trader.
And it is an interesting statistic that "90% of Retail Forex traders fail".
Kind of matches my guess that "98% of traders do not understand" their use of leveraging tools, to which I would add they have litle understanding of position sizing, trade management, risk management, margin calculation, stop loss calculation, risk:reward calculation, probability of success and so on.
Those traders that DO understand these things will know where I am coming from here.
I am no expert, by the way - I have also failed as a short term trader, and now am entrenched in the camp of the DAILY chart traders, using low leverage - and still confined to demo trading at the moment, until I get my confidence back to go live again ... if ever.
Until then, I remain a dull theorist!
Funny how it took a big whack to the side of the head with a 4 x 2 before I realised I was being duped by my own haste to make money.
But nothing gets my attention like LOSING money!
Just my view.
It seems FINRA is onto it too.
Best wishes
Ingot
, so I asked anyhow.
