Who Has More Leverage?

While professional currency dealers use 1:1 to perhaps 10:1 leverage, it is not uncommon for inexperienced retail clients to use

After the furor that was raised by retail traders when CFTC enacted the new anti-hedging policy, I am surprised that online forums have not been inundated with protests in anticipation of NFA’s new proposal to limit the leverage FDMs will be allowed to offer their clients.

When brokers offer higher leverage it generally encourages traders to trade larger positions, thus increasing the market maker’s trading volume and profits but also increasing the risk of a margin call for the trader.  The NFA proposal would limit leverage to 100:1 on ten major currencies and 25:1 on all others.

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I understand why some novice traders would assume that decreased leverage would inhibit their opportunity to make profits, but most don’t realize that leverage is a double-edged sword that can cut their trading lives short if not managed judiciously.  While professional currency dealers use 1:1 to perhaps 10:1 leverage, it is not uncommon for inexperienced retail clients to use leverage from 50:1 to 400:1 and, if they happen to trade with IG Markets, 700:1. 

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The intent of the proposed regulation is to protect over-leveraged traders and brokers alike.  However, some Forex brokers are concerned it may make them uncompetitive in the global market.   So, are the NFA and CFTC over-reacting to the current administration’s call for more transparency and tighter regulation?  The Foreign Exchange Committee (FXC) obviously thinks so. In a letter dated three days before Thomas Sexton (NFA Vice President and General Counsel) sent his proposed amendments to the CFTC, FXC transmitted their comments on a proposed rule establishing a leverage limitation to FINRA.  The FXC letter stated, “The FXC believes that the protections currently in place with respect to retail forex transactions are adequate to protect retail market participants and that the proposed Rule is unnecessary and potentially counterproductive.”

Earlier this week, when CMS Forex reduced their leverage offer from 400:1 to 100:1, it may have been done in anticipation of the proposed regulation.  The company’s press release used almost the exact language used in the NFA’s letter to the CFTC.  It stated, “We will be requiring 1% margin on the notional value of clients’ positions on the major currency pairs and 4% on the minor currency pairs.”

So who is going to win this battle?

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