I understand that it comes from other people’s deposits and from the broker’s capital. However, where is the limit? I understand that with stocks, its basically a loan from a bank, i.e., you will pay interest if you hold it for any appreciable amount of time.
Forex has only the interest rates on the currency themselves. But, there has to be limit, right? To do a crazy example, let’s say you dumped $10mil cash in a forex account. At 1:400, that would be $4 billion. That makes no sense since most brokers don’t have nearly that amount of capital - even if they did, it would leave no capital left for other traders to use.
So where exactly does the money come from? Most offer high leverage in comparison to stocks, or certain other instruments, so I’m just wondering how this is possible. I’m aware that not everyone will be using 100% leverage 100% of the time, but there still has to be limits.
Good question…I don’t have the answer,I hope someone does…but there has to be a limit on it…I’m sure that the fine print of a broker’s PDS will state one…
You’re making the mistake of equating forex with stocks. Stock trading is ownership based - you exchange ownership of shares. Forex is like futures in that you’re dealing in agreements. When you trade futures you are agreeing to do and exchange of assets at a future point. Same with forex. Basically, spot forex is a 2-day futures market. That’s why you have roll.
The reason this matters is that while margin in stock trading is basically a collateralized loan (like taking out a mortgage), margin in futures and forex is about surety against loss and has nothing to do with any ownership. The brokers don’t actually own any currency (aside from their capital and customer deposits, of course), and don’t do any actual currency exchanges, so they don’t need piles of capital to support the leverage they permit their customers.
Ahh that makes a lot of sense, rhody. Don’t know why I didn’t think of that before! Thanks for your response.
Do you know, though, if there is a limit? I seem to recall seeing a breakdown of leverage at a certain forex broker, although I can’t seem to find that page anymore. Basically, it was 1:400 up to $100k, but the numbers went down after that, or something.
Brokers set their permissible margin based on their risk management scheme. Since a large account has the potential to hurt the broker more if something happens which requires the broker to cover a major loss out of their own capital, they are going to be inclined to not permit as much leverage to big accounts. If a small account blows up, though, it doesn’t matter, so higher leverage is permitted.
I:) understand that it comes from other people�s deposits and from the broker�s capital. However, where is the limit? I understand that with stocks, its basically a loan from a bank, i.e., you will pay interest if you hold it for any appreciable amount of time.
Forex has only the interest rates on the currency themselves. But, there has to be limit, right? To do a crazy example, let�s say you dumped $10mil cash in a forex account. At 1:400, that would be $4 billion. That makes no sense since most brokers don�t have nearly that amount of capital - even if they did, it would leave no capital left for other traders to use.
I think this is an interesting post so I decided to post my fourth comment on this forum!
I hope rhodytrader and other experts can join to clarify things.
It is understood that market makers may never provide actual funding if they think they can handle the matter internally (as already explained.) That is fine.
However, what happens when it is an ECN or when you trade directly with the bank such as dbfx (deutche bank forex) which provides leverage directly?
Is there a limit? Is there real money? In other words, does the bank need to have sufficient capital or to seek sufficient capital from the market to cover your position?
Is it all about the settlement? Or there has to be real capital covering the position?
Does dbfx for example segregate capital for me to trade?
Consider this statement by InvestTech which is a leading STP Canadian broker, when talking about banks in the interbank system:
[I]“Because payments are made on the net position for each currency, the bank reduces the funding necessary by up to 95%.”[/I]
I feel big banks are just like other brokers in the sense that they do not provide real funds in most cases, i.e. they do not need to have enough capital to cover any position, i.e. they are not limited by the amount of capital they have.
However, these banks have a superior edge because of superior turnover and the mighty ability to offset positions from different clients all around the clock, which allows them to guarantee 99% of all orders. Is this an accurate statement?
Spot forex is very similar to the futures market in that it’s the posting of margin which is the focal point. Keep in mind that a spot trade is a 2-day delivery agreement - like a short duration futures/foward contract. In the speculative arena (meaning all of retail forex) there is no actual transfer of currency. That means there no requirement for the capital to accomplish those kind of exchanges. All the brokers need is the capital to cushion against the day to day fluctuations in prices - which is what our margin requirements are used for.
Therefore, the limits to how big trading can get is based on the amount of available margin capital and having someone willing to take the other side.
Oh, and brokers do not offer 400:1 leverage on large accounts. The risks to them are too large in the case of a sharp adverse move wiping out the account-holders leverage and putting them in a deficit situation.
but what is the difference in this context between dealing with (ECNs and directly with the banks like dbfx) and retail market makers? do they follow basically the same concepts in managing clients’ orders?
You said brokers do not offer 400:1 leverage on large accounts because of the mentioned risk? Will an ECN face the same risk as well, give that the STP your orders to the banks? And will dbfx face the same risk despite being the liquidity provider?
Because market making brokers (non-ECNs) are subject to exposure if customer positions become imbalanced, they obviously have capital needs beyond those of pass-through brokers (ECNs). ECNs are essentially the same as futures brokers. They maintain the requisite margin on behalf of the customers against positions held away. And yes, the ECNs would face the risk associated with the high leverage ratios because they are responsible for to the liquidity provider against whom the positions are held - the same way a futures broker is responsible to the exchange/clearing house.