Forex Leverage: How is it provided? What is the mechanism?

G

Good1

Hi, i am genuinely unknowing and curious about the availability of leverage in the forex market. Brokers are/were typically offering 100:1 and i've even heard of 900:1. Then the U.S. said their citizens can only go up to 50:1 (but i've noticed they allowed two brokers/banks to continue to offer 100:1). Irregardless of whether it is good or bad (whether we should have more or less), i'm interested in how is it possible?

So i'll offer my first guess: Depending on how capitalized a broker is, it will offer the leverage, even if it is a market maker, because it knows that most accounts will lose money. Therefore, if they offer more leverage, they will simply make money faster.

How close am i to the truth?
 
Being a market maker doesn't mean the broker profits when you lose. Often a broker will hedge their net exposure.

Liquidity is provided easily since you're effectively holding money... the most liquid thing there is by definition.

The broker doesn't put the cash up for you though, their Liquidity Provider (LP) usually does. The broker just promises to be "good for it", since they have your deposit to put up as margin with their LP. The LP in turn passes through any interest difference on the currency pair position (which the broker usually marks up and passes on to you.)

Leverage is also commonly higher than other markets since currencies don't exactly move quickly under normal market conditions. The bid/ask spread is often measured in hundredths of a penny increments, so it takes a decent amount of leverage to see significant short term gains/losses... remember, the Euro isn't like a penny stock, moving 10-20 cents in value can take months and involve many trillions of dollars to push it.
 
Quote from rmorse:

I believe 50:1 in the US is max leverage. Who in the US offers more?
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I'll try to dig up where i read that. I've read so much lately it may take a while. But if i recall, i remembered it because the two banks were listed among what some are saying is a kind of cabal of banks favored by the top tier, if you know what i mean. I remembered it because it looked to me like they were U.S. institutions, and i remember thinking it gives them an unfair advantage over the rest (what else is new).
 
Quote from Jack_Larkin:

Being a market maker doesn't mean the broker profits when you lose. Often a broker will hedge their net exposure.

Liquidity is provided easily since you're effectively holding money... the most liquid thing there is by definition.

The broker doesn't put the cash up for you though, their Liquidity Provider (LP) usually does. The broker just promises to be "good for it", since they have your deposit to put up as margin with their LP. The LP in turn passes through any interest difference on the currency pair position (which the broker usually marks up and passes on to you.)

Leverage is also commonly higher than other markets since currencies don't exactly move quickly under normal market conditions. The bid/ask spread is often measured in hundredths of a penny increments, so it takes a decent amount of leverage to see significant short term gains/losses... remember, the Euro isn't like a penny stock, moving 10-20 cents in value can take months and involve many trillions of dollars to push it.
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Oh ok, i think i get it, especially the last part. If the average daily range of a currency pair is only .002%, for example, then yah, it would take forever to realize much of a gain, and the only one's that may be interested in that game would be few. So leverage helps attract traders, which provides more liquidity (which is better).

I'm a little gray though about the liquidity provider (LP). It's not the broker who does this? So are there relatively few LPs compared to the number of brokers...and they are all kind of accessing these LPs? Can you name an example of an LP?
 
The liquidity providers are typically banks. But after the trade, your broker must cover all counter party risk on your behalf. If a bank fails to meet their obligation when you unwind the pair, your broker is responsible. When you enter into these swaps, you don't actually swap the currency. You are agreeing to cover the change in price when you unwind the pair. The trade is called a non-deliverable swap.
 
CitiBank

Quote from Good1:

Thanks, yes it does appear 50:1 (20:1, depending on the currency) applies to everyone. That's why i was surprised when i saw those two banks to whom the rules for everyone else did not apply. I'll definitely try to dig that up.
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