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I heard today that all Forex traders are forced by the Forex companies to use large leverages.

Is this true? I understand this might be good for some companies, but possibly bad for the traders. How come that all Forex companies do this (if true), and no company allows to just trade without leverage?

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4 Answers 4

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While it's not true that you have to use leverage to participate in Forex, the alternative makes it impractical for most people to be able to do so. You need to be able to put a lot of money into it in order to not trade on leverage.

The fact is, most accounts for "normal" people require leverage because the size of the typical contract is more than the average person can afford to risk (or usually more than the average person has).

Leverage, however, in the Forex market is not like Leverage in the stock or commodities market (well, they're the same thing in theory, but they are executed differently). In Forex, the broker is the one lending you the money in nearly all cases, and they will cash out your position when your account balance is exhausted. Thus, there is no risk for them (barring fraud or other illegal issues). Technically, I don't believe they guarantee that you will not accrue a debt, but I've never heard of anyone having their position cashed out and then owed more money. They've very good about making sure you can only spend money you've deposited.

To put this another way, if you have $1,000 in your account and you are leveraged to 100,000. Once your trade drops to $1000 in losses your position is automatically cashed out. There is no risk to the broker, and no risk to you (other than your $1000)... So trading without leverage has little value, while traiding with leverage has lots of potential gain and no downsides (other than a faster rate of loss, but if you're worried about that, just trade smaller lots.)

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It isn't that the companies force traders, it is more the other way around. Traders wouldn't trade without margin. The main reason is liquidity and taking advantage of minor changes in the forex quotes. It goes down to pips and traders make profit(loss) on movement of pips maybe by 1 or 2 and in some cases in 1/1000 or less of a pip. So you need to put in a large amount to make a profit when the quotes move up or down.

Supposedly if they have put in all the amount upfront, their trading options are limited. And the liquidity in the market goes out of the window. The banks and traders cannot make a profit with the limited amount of money available at their disposal. So what they would do is borrow from somebody else, so why not the broker itself in this case maybe the forex company, and execute the trades. So it helps everybody. Forex companies make their profit from the fees, more the trades done, more the fees and hence more profit. Traders get to put their fingers in many pies and so their chances of making profits increases. So everybody is happy.

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No one is FORCED to use leverage. But most people do.

Trading companies like it because, the more leverage, the more "business" (and total commissions). If someone starts with $1 million and leverages it up ten times to ten million, companies would rather do ten million of business than one. That's a given.

On the other hand, if you're Warren Buffett or Bill Gates, and you say I want to do $1 billion of FX, no leverage, no trading company is going to turn it down.

More often, it's a company like IBM or Exxon Mobil that wants to do FX, no leverage, because they just earned, say $1 billion Euros. Individuals USUALLY want to use more leverage in order to earn (or lose) more with their capital.

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I recommended Currency Trading For Dummies, in my answer to Layman's guide to getting started with Forex (foreign exchange trading)? The nature of the contract size points toward only putting up a fraction of the value. The Euro FX contract size is 125,000 Euro. If you wish to send the broker US$125K+ to trade this contract, go ahead. Most people trade it with a few thousand dollars.

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I'm sorry, did you answer my question (no sarcasm here)? Can you explain it like I'm five? Links are great, but first tl;dr and answer the question ... pretty please :) –  ripper234 Jan 22 '12 at 4:51
    
Because standard contracts are valued at $100K+. In which case, most traders would be able to participate in very little action. If you wish to put up the full amount, there's no issue. –  JoeTaxpayer Jan 22 '12 at 21:33

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