Leverage, I dont understand the principle of it...

C

capitalistsmith

I dont get the principle of why it is brokers are allowing us speculators extra cash to trade with to profit from potentially larger gains.

Now, dont get me wrong, I understand the principle of leverage and the fact that the broker is wanting you to potentially expose yourself to a larger risked position (especially if they`re a market maker) to capitalize not only from the spread but from your loss if they`re trading against you.... (in which case its just artificial leverage right? - I mean, they`re the counter party to your trade, so your money doesnt go any further than the broker themselves)

However, If i traded through, lets say, IBFX who offer 1:50 leverage, why are they willingly giving me there physical cash to leverage up on a position when they only make profits out of the spread (commission) and the trade gets sent over to their liquidity providers?

I know im definitely missing something here, but I cant seem to figure it out why they`d take this risk in allowing me to trade with more money (50x) than what I have on deposit!?


Would be great if someone can explain to me in really basic laymans terms (analogies are welcome :D )
 
Interest. Also, when one broker starts offering more leverage, the others need to follow to remain competitive.
 
Because you wouldn't (or couldn't trade) without leverage. No clients = no business model.

The leverage a broker/dealer provides isn't a big risk. Risk controls are built into the platform that liquidate customer positions after their margin (accnt balance) is wiped out, or close to it.

And banks provide leverage to b/d'ers, who extend it to customers. It's not the brokers own money used for leverage, afaik.
 
Once a few brokers introduce something, the rest must follow or lose customers. Also with electronic trading, there is very little risk that someone using leverage will blow out the firm. There are many tools that are available to keep the firm safe. Leverage also gives firms more profit by increasing the pool of people that can trade. Could someone trade futures or even bother trading forex with 20k? I doubt it, but that is certainly enough money to open an account with the leverage available.

Just because the leverage is available doesn't mean you have to max out your margin availability for every trade. That just doesn't happen most the time and when it does, you'll probably be blowing up your account one day.
 
So you`re saying I could trade a £20k account with 1:1 leverage...

Why is there cash being thrown around to completely in-experienced traders who have the capacity to blow up their account and more just because "brokers/dealers" (for what reason?) are being provided leverage and they give this to their clients?

If this is all regulated by the FSA then what the hell is it im missing?

If i put £1000 into an account that offers me 1:50 does that mean i`m physically trading a £50,000.00 account?

Why are they giving this to me.... Are they not recieving a small percentage of margin from a 1 lot position and having to put up a HUGE amount more to be sent off to the liquidity providers (if ECN+STP) and exposing themselves to ridiculous risk without knowing if my trade is going to be profitable or not :s?
 
You pretty much sign an agreement that says you aren't inexperienced and understand the risks and could possibly lose all of your funds, so they put it on you. Yes, theoretically you could lever that 1k into 50k, but no one serious does that. Also realize that one pip move on 50k is only $5. Hardly something that would blow you out.
 
Do a bit of research on why certain markets <b>require</b> leverage as a basis for their existance. You can start here but if you want a thorough education on the uses, advantages, and disadvantages I'd suggest you spend some time googling it.

<i>The reality is that professional traders trade using leverage every day because it is an efficient use of their capital. There are many advantages to trading using leverage, but there are no disadvantages whatsoever. Trading using leverage allows traders to trade markets that would otherwise be unavailable. Leverage also allows traders to trade more contracts (or shares, or forex lots, etc.) than they would otherwise be able to afford. However, the one thing that trading using leverage does not do, is increase the risk of a trade. There is no more risk when trading using leverage, than there is when trading using cash.</i>

http://daytrading.about.com/od/daytradingbasics/a/Leverage.htm
 
I know a few who have done just that so if I know a few it means there are plenty who do this very thing :).

Quote from ExchangeBonds:

Yes, theoretically you could lever that 1k into 50k, but no one serious does that.
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Good point!

Quote from ExchangeBonds:

Also realize that one pip move on 50k is only $5. Hardly something that would blow you out.
More...
 
....Imagine you caught a single penny move (100 pips) going long the eurusd. At 1:1 leverage, your realized profit is ~0.8% of your account balance. Most profitable traders don't make 100 pips, a week. That's the point. Without leverage, trading is a futile endeavor for retailers with less than 10 million in their account. Leverage makes (profitable) trading worthwhile because then a small stake can be traded up into something meaningful.
 
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