I have a basic understanding of leverage.
My questions are, the money that is “borrowed” from the broker;
Is it real money that the broker borrows / gives to the trader?
When the trader loose money who pays? Meaning the broker placed a hold on a percentage of the traders margin. E.g. Account balance=$1000 Used margin=$100(placed on hold) Usable margin=$900 Leverage=100:1 Position size=$10000. If the trader loose, does he only loose his used margin? Who looses the other $9900?
Apologies if my my question does not make sense. If so then I do not have a basic understanding of what leverage is. But I have been wondering about this since I learned about leverage. Why would the broker give leverage to amplify gains / losses if they could loose or gain a lot?
its easier then that.
the 100 are beeing held as margin, as reserve, which guarantee your trade. they never change as long as you are in the trade. the 900 you have left are on stake. so lets say you loose 150 then your used margin still stays 100 but your account balance isnt 1000 (100+900) but 850 (100+750) so you lost 150 from your left over 900.
Now about the who looses the other 9900 part. it doesnt work like how you imagine it in your scenario. when you do a leveraged trade where the leveraged amount is 10.000 and you have a account balance of 1000 which is 100 margine then you fully participate on the 10.000, but you dont feel it like 10.000 as its margined and the real moves on currencies are so small that if you wouldnt leverage you wouldnt see much difference.
so from the 10.000 you bought/sold you are only participating in them., so lets say the value of those 10.000 falls to 9500 then your account is going to suffer a loss of 500, the margin is still staying 100 so “usable margin” will be 400.
You can immagine your margin as “buffer zone” which is like minimum you have to have to stay in the trade, the rest (usable margin) is what you are truly risking in every trade.
Once your “usable margin” reaches 0 then you will be automatically kicked out (margin call) of the trade and the 100 margin they held as security is beeing given back to you.
So in the 10.000 example of yours, if the price falls from 10.000 to 9.100 you will be kicked out (margin call) as you are left without usable margin anymore (100 used margin minus 900 loss on trade = 0) and your account will show the following numbers then:
Usable Margin: 100
Used margin: 0
Account gain/loss: -90%
so the question of “who pays the rest of the 9900?” is answared like this: noone, only you.
[B]There is no borrowing of money in retail forex trading.[/B]
No broker in his right mind would lend you money to blow on something as risky as currency trading!
Leverage is simply a mechanism for placing a bet that is larger than the balance you have on deposit with the broker.
When you take a position (place a bet) in the retail forex market, you are putting your broker on the other side of your position (bet). That is, if you go LONG, you automatically place your broker in a SHORT position, because he is the [I]counterparty[/I] to your position.
Your position is a naked gamble, but your broker probably doesn’t want to gamble with your chosen currency pair — even if he thinks you have taken a bad bet. So, he will offset the SHORT position that you have put him in, by taking an equivalent LONG position upstream with his liquidity provider (bank). Now, if your bet turns out to be a winner, meaning that his position as your counterparty is a loser, his loss is completely offset by the winning position he holds with the bank. He is perfectly hedged. He can’t profit from your loss (if you lose), and he can’t suffer a loss if you win.
If your position starts to become a loser, your loss will increase in proportion to the actual leverage you have used. In your example ($1,000 account, $10,000 position), you are using 10:1 actual leverage. An adverse move (in pips) against your position will be [I]10 times as severe in monetary terms,[/I] with 10:1 actual leverage, as it would be if you were using only 1:1 actual leverage.
[B]As your leveraged loss mounts, your unused margin will be consumed.[/B] In your example, your leveraged loss will start to eat up the $900 of unused margin, that was not set aside initially as required margin (used margin).
After your leveraged loss has consumed all of your $900 [I]unused[/I] margin, further losses will start to eat into the remaining $100 of [I]used[/I] margin. At some point, before your loss has consumed all of the remaining $100, your broker will shut you down.
Your broker is not going to allow you to lose more money than you have in your account. In other words, [B]your broker is not going to allow you to lose any of his money.[/B]
When you lose, the loss comes out of your unused margin (the $900 in your example). If you burn through all of your unused margin, look out — because you’re going to face a margin call and get your position closed involuntarily, before you have lost all of the used margin (the $100 in your example). In other words, your total loss in this worst-case scenario will be something less than the $1,000 balance in your account.
As for your last question, [B]there is no $9,900 loss — not for you, and not for your broker.[/B] The only loss incurred is the loss referred to above — something less than $1,000. And that loss will be entirely your loss, in real cash money.
Your broker will break even, no matter what, because his position is offset with the bank. He will collect a spread from you, and that’s his profit for the service he has provided to you.
Thank you for the lots of information. I retract my statement about having a basic understanding of leverage. I will have to re-read the 2 posts above a few more times and more reading, youtube, google etc. and then re-evaluate how much I understand about leverage.
One thing what you should know besides how the leverage work is that, if you have a proven good trading strategy than the leverage is a good idea for you since it will increase you profits much faster. However, if you don’t have a good trading strategy than leverage will increase your losses to.
Modern systems and the availability of liquidity assures the broker that it can close your trade within a number of pips. So they calculate how large your stake can be and see if that gives them enough room to close any of your trades before your accounts is blown. From that they can calculate how much leverage you are allowed to trade with. So all rules they apply are ment to protect them (but still make it interesting enugh for you to trade with them).
So no money is borrowed, it is just risk management for them with your accountbalance as stake.
Margin trading in the forex market differs from how it works in the stock market.
In the stock market, when you trade on margin, you do borrow the rest of the money needed to purchase the stock from your broker.
In the forex market, you do not borrow money from your broker. Instead, margin in the forex market works like a deposit allowing to control a larger trade size (i.e. take on the risk of a larger trade size in the market).
An analogy would be how one rents an apartment. The landlord asks for a security deposit upfront. This is like the margin you put up to open your forex trade. The real estate value of the apartment is many times more than the security deposit, just like the notional value of your forex trade can be many times greater than the margin you have in your account.
The security deposit and the forex margin serve a similar purpose. The security deposit is there to cover damage that may occur to the apartment while you live there such as to the carpet or walls that need repainting. The forex margin is there to cover losses that may occur while you are in your trade.
As long as you keep paying your rent and don’t damage the apartment, the landlord will let you stay. As long as you maintain adequate margin your account, you can keep your trade open with your forex broker.
Forex brokers offer you leverage to magnify your gains and losses, because the actual price movements in the forex market for major currency pairs are relatively small compared to stocks. In a typical day, the EUR/USD exchange rate will change by less than 1 cent. That’s why currency prices are measured in hundredths of a cent called pips, and even thousandths of a cent called pipettes.