Forex trading is growing in popularity thanks to the gains generated by most traders.
Apparently, some traders get into the forex market because of the leverage offered by forex brokers.
Forex brokers provide some extra capital (leverage) to traders to enable easy control for significant trade positions with merely small amounts of money.
Pricing of currency pairs in forex is quoted to 4or5 decimal points.
Therefore, it means that a slight movement of the pair is worth 0.0001 points or simply 1/10000th of a point.
One of the reasons why so many people are attracted to trading forex compared to other financial instruments is that with forex, you can usually get much higher leverage than you would with stocks. While many traders have heard of the word “leverage,” few know its definition, how leverage works and how it can directly impact their bottom line.
The concept of using other people’s money to enter a transaction can also be applied to the forex markets. In this article, we’ll explore the benefits of using borrowed capital for trading and examine why employing leverage in your forex trading strategy can be a double-edged sword.
Leverage is intended to increase the trader’s reward at large.
It works in the sense that, even if a trader can come up with a full margin that is required for a trade, the potential gain without leverage would be small.
Any losses or profits from the leveraged trades are from the trader in full.
That asks the question of where the balance of a trade margin comes from. That’s where the broker comes in; the broker, therefore, assumes a risk in a trade.
However, with a margin call, brokers have the ability to control the risk.
What it means is that when a trade is losing money to the extent of doing away with the trader’s margin, the broker then issues a margin call.
Does the Margin Call Work the Trick for Brokers to Control the Risk?
Margin calls usually act the trick for the brokers to control the risks. However, there’re some market events that the margin call gets beaten and rendered, unable to control the risk.
For instance, if massive volatility does occur in a flash, it becomes almost impossible for brokers to use the margin call to close orders.
Why Political Events?
In most cases, the financial news does have consensus numbers which are used or serve as the foundation of predicting the direction as well as the market impact of various news releases.
However, with political events, they have nothing as a basis of reference for the market impact.
What it means is that there’s no way you can predict how the market will respond to a given political event.
It’s an obvious example as realized from the surprise Trump victory as well as the 48-hour market response.
Therefore, with a political event, anything is possible, and literally, nothing is impossible.
Currently, forex brokers now send messages early to their clients to warn them of the leverage adjustments in the currency pairs that would be affected by the major political events.
Therefore, it’s clear that the brokers sometimes can’t reduce the risk as a result of a political event.
For that reason, they take precautions early by minimizing exposure by decreasing the leverage provisions to even 1:50 in those days that precede a political event.
But why do they adjust the leverage?
Reducing the leverage offered to traders, brokers also increase the trader’s margin requirements.
Basically, reducing leverage increases the money a trader requires in the opening as well as maintaining a trade position.
Simply put, forex brokers adjust the leverage to clearly protect themselves from high losses during the high impact political news events.
Risk of Excessive Real Leverage in Forex Trading
This is where the double-edged sword comes in, as real leverage has the potential to enlarge your profits or losses by the same magnitude.
The greater the amount of leverage on the capital you apply, the higher the risk that you will assume. Note that this risk is not necessarily related to margin-based leverage although it can influence if a trader is not careful.