Abstract：The term "leverage" often appears in finance areas including security market and foreign exchange market, and its essence is to use a small amount of funds for larger amounts of trading.
For those who don't know much about financial transactions may not be able to imagine how to use a small amount of money for high-value transactions, because we can't use $1 for a trading of $10 in the real world. In financial markets(especially forex markets) such deals abound.
What is Forex Leverage？
Forex Leverage is a way for a trader to trade much bigger volumes than he would, using only his own limited amount of trading capital.
Leverage involves borrowing a certain amount of the money needed to invest in something. In the case of forex, money is usually borrowed from a broker. Forex trading does offer high leverage in the sense that for an initial margin requirement, a trader can build up—and control—a huge amount of money.
How Leverage Impacts Investors' Trading？
With a leveraged forex contract, you invest in a currency “on margin”, which means you only need to pay a certain amount - usually a small percentage of the contract amount, and you expect that the currency will rise or drop against another currency. Your profit or loss depends on the difference between the exchange rate when you open and close your contract.
Leverage in Forex Trading
In the foreign exchange markets, leverage is commonly as high as 100:1. This means that for every $1,000 in your account, you can trade up to $100,000 in value. Many traders believe the reason that forex market makers offer such high leverage is that leverage is a function of risk. They know that if the account is properly managed, the risk will also be very manageable, or else they would not offer the leverage. Also, because the spot cash forex markets are so large and liquid, the ability to enter and exit a trade at the desired level is much easier than in other less liquid markets.
In trading, we monitor the currency movements in pips, which is the smallest change in currency price and depends on the currency pair. These movements are really just fractions of a cent. For example, when a currency pair like the GBP/USD moves 100 pips from 1.9500 to 1.9600—that is, just a 1 cent move of the exchange rate.
This is why currency transactions must be carried out in sizable amounts, allowing these minute price movements to be translated into larger profits when magnified through the use of leverage. When you deal with an amount such as $100,000, small changes in the price of the currency can result in significant profits or losses.
High Leverage VS. Low Leverage
Using Maximum Leverage
Imagine Trader A has an account with $10,000 cash. They decide to use the 50:1 leverage, which means that they can trade up to $500,000. In the world of forex, this represents five standard lots. There are three basic trade sizes in forex: a standard lot (100,000 units of quote currency), a mini lot (10,000 units of the base currency), and a micro lot (1,000 units of quote currency). Movements are measured in pips. Each one-pip movement in a standard lot is a 10 unit change.
Assuming the trader purchased five standard lots with the U.S. Dollar as the quote currency, then each one-pip movement will cost $50. If the trade goes against the investor by 50 pips, the investor would lose 50 pips x $50 = $2,500. This is 25% of the total $10,000 trading account.
Using Less Leverage
Let's move on to Trader B. Instead of maxing out leverage at 50:1, they choose a more conservative leverage of 5:1. If Trader B has an account with $10,000 cash, they will be able to trade $50,000 of currency. Each mini-lot would cost $10,000. In a mini lot, each pip is a $1 change. Since Trader B has 5 mini lots, each pip is a $5 change.
Should the investment fall that same amount, by 50 pips, then the trader would lose 50 pips x $5 = $250. This is just 2.5% of the total position.
What Are the Pros & Cons of Trading with High Leverage in Forex？
After knowing the basic information about leverage, it seems that benefits of high leverage are obvious, but you have to know that you risk in proportion to the opportunity to amplify your returns. Below we delve into the benefits and defects of high leverage trading when you embark on forex trading.
Why do Forex Brokers Offer High Leverage？
There are a number of reasons why a forex broker offers high leverage. Whatever the reasons may be, one of the common reasons is because a higher leverage attracts the gullible trader.
Traders end up trading with high leverage and with just $100 and hope that they can make a quick buck. Unfortunately, the high leverage is a ticking time bomb that is waiting to bankrupt the trader sooner than later.
This is why many professional forex brokers do not encourage leverage of more than 1:200. At the same time, licensed forex brokers must obey the global regulators' leverage restrictions, so what are global regulators' leverage restrictions？
What Are Global Regulators' Leverage Restrictions？
Several years of regulatory wrangling has culminated in yet another blow to the CFD market, many regulators which have passed new regulations such as ASIC, FCA and CySEC severely limiting how CFDs are sold, executed and marketed, and restricting leverage considerably.
Global Regulators' Leverage Limits
ASIC's leverage restrictions
From 29 March 2021, ASIC's product intervention order will:
restrict CFD leverage offered to retail clients to a maximum ratio of:
30:1 for CFDs referencing an exchange rate for a major currency pair
20:1 for CFDs referencing an exchange rate for a minor currency pair, gold or a major stock market index
10:1 for CFDs referencing a commodity (other than gold) or a minor stock market index
2:1 for CFDs referencing crypto-assets
5:1 for CFDs referencing shares or other assets
The UK FCA's leverage restrictions
The FCA have finalised rules restricting how CFDs and CFD-like options are sold, marketed, and distributed to retail consumers.
·Limit leverage to between 30:1 and 2:1 depending on the volatility of the underlying asset.
·Close out a customer's position when their funds fall to 50% of the margin needed to maintain their open positions on their CFD account.
·Provide protections that guarantee a client cannot lose more than the total funds in their trading account.
·Stop offering current and potential customers cash or other inducements to encourage retail consumers to trade.
·Provide a standardised risk warning, telling potential customers the percentage of the firm's retail client accounts that make losses.
The CySEC's leverage restrictions
CySEC is proposing to prohibit the marketing, distribution and sale of leveraged CFDs on crypto assets to retail clients, unless they fall within the upper tier of the positive target market to prevent exposure to excessive risk caused by the extreme volatility of the
instrument.
Proposed leverage limits for each asset class compared with ESMA's temporary product intervention measures include:
Retail clients falling within the “grey” target market (neither negative nor positive) will have extra protective measures via increased leverage limits:
·20:1 to trade major currency pairs (30:1 under ESMA);
·10:1 to trade non-major currency pairs (20:1 under ESMA);
· 5:1 for “grey” to trade commodities other than gold (10:1 under ESMA);
· 2:1 to trade individual equities (5:1 under ESMA);
·1:1 on crypto assets (2:1 under ESMA).
Retail clients falling within the positive target market will be subject to the same leverage limit as under ESMA's measures, except for the case of CFDs on crypto assets:
·30:1 for major currencies (30:1 under ESMA)
·20:1 for non-major currencies (20:1 under ESMA)
·10:1 on commodities (10:1 under ESMA)
·5:1 on individual equities (5:1 under ESMA)
· 1:1 on crypto assets (2:1 under ESMA).
Retail clients falling within the upper tier of positive target market, subject to the satisfaction of customer due diligence and client suitability tests, will be able to access higher-yield trading strategies under slightly increased leverage limits:
·50:1 for major currencies (30:1 under ESMA)
·30:1 for non-major currencies (20:1 under ESMA)
·20:1 on commodities (10:1 under ESMA)
·10:1 on individual equities (5:1 under ESMA)
·2:1 on crypto assets (2:1 under ESMA).
ESMA's leverage restrictions
The European Securities and Markets Authority (ESMA) has agreed to renew the restrictions on the marketing, distribution or sale of contracts for differences (CFDs) to retail clients on 26 March 2019 and includes renewing the following:
Leverage limits on the opening of a position by a retail client from 30:1 to 2:1, which vary according to the volatility of the underlying:
30:1 for major currency pairs;
20:1 for non-major currency pairs, gold and major indices;
10:1 for commodities other than gold and non-major equity indices;
5:1 for individual equities and other reference values;
2:1 for cryptocurrencies;
According to the regulatory documents, other regulators (besides we mentioned the above) also follow the tightened leverage policies, many changes include leverage restrictions of no more than 200:1, aban on binary options trading for retail clients and marketing restrictions limiting cold calling and other aggressive marketing tactics. If you have a forex broker who offers related services in jurisdictions such as the US, Canada, Russia, Poland, Japan, Hong Kong(China), Singapore and Malaysia... it must apply to the strict leverage limits. However, offshore jurisdictions still remains highly leveraged.
After knowing the global regulators' leverage restrictions, we will show you three of the most important regulatory bodies with their leverage policies and the best forex brokers regulated by them to help your trading and investment decisions.
How to Choose the Right Leverage？
There's nothing like ideal leverage. What we need to do is reviewing before choosing a leverage level. You can follow these three rules:
1. Stay patient in low levels of leverage.
2. You can use trailing stops to reduce downside and protect your capital.
3. Limit your capital to 1-2 percent of total trading capital on each position you're taking.
Is There Any Way You Can Change Leverage When Trading？
Generally speaking, leverage can't be changed when you open an account. However, some forex brokers allow you to change leverage on your account. For example, you can do so in your Personal Account by yourself or contact with the customer services. If there are no placed orders and open deals on the account, leverage can be either decreased or increased. If there are open positions, your leverage can be changed only upwards.
When should you change your leverage？ If the account has already experienced losses, it's better to stem the risks by reducing leverage. This will enable you to recover your losses carefully.
Leverage is a great opportunity to make more money with less startup capital. However, any trader should use it wisely in order to achieve the goals.
