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Where does Leverage come from?
- Thread starter Jetheat
- Start date
Quote from Jetheat:
Sorry, I just wanted a laymans explanation if you have one.
I'm a bit thick.
Sorry but it's for laymans. If I wanted to I would have given an exerpt from a financial book. If you consider that it is too much for you it doesn't matter I don't answer for you in particular but for anybody.
Below also is an official faq for Laymans by Congress as it is said "Transmitted herewith for the use of the Subcommittee on Domestic Finance of the Banking and Currency Committee, and other members of the committee and the Congress, as well as the general public, is a series of questions and answers on the basic workings of our monetary system. It is a supplement to "A Primer on Money" and is designed to highlight in question and answer form the basic points brought out in the "Primer."
http://landru.myhome.net/monques/moneyfacts.html#MONEY
MONEY FACTS
SUBCOMITTEE ON DOMESTIC FINANCE
COMMITTEE ON BANKING AND CURRENCY
HOUSE OF REPRESENTATIVES
88th Congress, 2nd Session
SEPTEMBER 21, 1964
47. Where does the Federal Reserve get the money with which to create bank reserves?
It doesn't "get" the money; it creates it. When the Federal Reserve writes a check, it is creating money. This can result in an increase in bank reservesâa demand depositâor in cash; if the customer prefers cash, he can demand Federal Reserve notes, and the Federal Reserve will have the Treasury Department print them. The Federal Reserve is a total moneymaking machine. It can issue money or checks. And it never has a problem of making its checks good because it can obtain the $5 and $10 bills necessary to cover its checks simply by asking the Treasury Department's Bureau of Engraving to print them.
48. Who gave the Federal Reserve the power to create the money necessary to cover its checks?
The Congress. Because this power to create money is given by the Constitution to Congress, only the Congress can delegate this power. And this it has done in creating the Federal Reserve Systemâan agency of Congress authorized to create money.
49. How does the Federal Reserve change the money supply?
First, by increasing or decreasing the amount of bank reserves which the member banks of the Federal Reserve System have to their credit on the books of the Federal Reserve banks. Second, by regulations which tell the member banks the maximum amount of bank deposits they may create per dollar of reserves.
50. What is the formula that determines the maximum amount of money available to business and consumers?
Expressed mathematically this is a simple formula A Ã B = C where: A = Amount of bank reserves; B = Number of dollar deposits member banks may create per dollar of bank reserves; and C = Total bank deposits.
51. Can the Federal Reserve authorities change the money supply formula?
Yes. They can change either or both parts of the formula at any time, and they frequently do change one or both parts. There are certain limits set by the Federal Reserve Act to the changes the authorities can make. But these limits are extremely wide.
52. Does it make any difference which part of the formula the authorities change when they wish to increase the money supply?
Yes. Although the effect on the money supply of changing either part of the formula may be the same, the total economic effects differ depending on which part of the formula is changed. For example, when the Federal Reserve lowers reserve requirements, all of the new money is created by the commercial banks through their lending and investing activity. This obviates the necessity of transferring Government securities from private to public hands. On the other hand, when the Federal Reserve increases reserves by, say, purchasing U. S. Government securities, the interest income on these securities goes to the Federal Reserve System. Since the Federal Reserve turns over to the U. S. Treasury most of its earnings, the net effect of increasing the money supply by increasing reserves is to favor the private banking system. So, when the Federal Reserve officials decide to increase the money supply, whether they favor the U. S. Treasury or the private banks does make a differenceâin the amount of taxes you, I, and all other taxpayers must pay.
It is a straight up loan secured by the value of the securities. Much the same as the 5-20% you put down for your house. You are, in effect, leveraged up to buy the house, with difference secured by the value of the house.
The Fed can change margin requirments as they see fit. One of the causes of the crash of 1929 was that many traders where allowed 10:1 leverage, which of course really exasperates the selling as brokerages have to sell more and more traders out of there positions as prices cascade.
The important thing to keep in mind about highly leveraged positions is that the position can be FORCED to liquidation. If you own the stuff outright, no one can force you to sell it, whether it is a house, a car or a stock.
In my opinion, leverage is the death of most traders. As one of many examples, look at the results of the audited market timers who use Rydex or Profunds vs the Fidelity traders.
Best,
Mike
The Fed can change margin requirments as they see fit. One of the causes of the crash of 1929 was that many traders where allowed 10:1 leverage, which of course really exasperates the selling as brokerages have to sell more and more traders out of there positions as prices cascade.
The important thing to keep in mind about highly leveraged positions is that the position can be FORCED to liquidation. If you own the stuff outright, no one can force you to sell it, whether it is a house, a car or a stock.
In my opinion, leverage is the death of most traders. As one of many examples, look at the results of the audited market timers who use Rydex or Profunds vs the Fidelity traders.
Best,
Mike
Jetheat,
Ignore Harrytrader for now - he's either brilliant or crazy, most of us haven't decided which, yet. Either way he'll probably just confuse you.
So far you've gotten a few replies that contradict each other a little because you haven't told us what you are trading. The nuances of leverage and market markers differ slightly whether you are dealing with equities, commodeties, futures, or spot-fx.
To answer your other question, the broker IS the market maker (in the case of retail fx). They take your orders and then trade against you - yup it's good to be the casino!
Ignore Harrytrader for now - he's either brilliant or crazy, most of us haven't decided which, yet. Either way he'll probably just confuse you.
So far you've gotten a few replies that contradict each other a little because you haven't told us what you are trading. The nuances of leverage and market markers differ slightly whether you are dealing with equities, commodeties, futures, or spot-fx.
To answer your other question, the broker IS the market maker (in the case of retail fx). They take your orders and then trade against you - yup it's good to be the casino!
maybe this is a thick question, but i have wondered the same, who is making me these rather large interest free loans every day, and isnt there significant opportunity cost (not to mention default risk) on their capital? do the extra commissions truly make up the balance. maybe their loans are a small price to pay for the use and posession of my capital, but then its tied up and then some during most of the US trading day. do they repo our funds every night into a fortune
i wonder where a broker like IB is comfortable keeping the total level of margin loans in relation to total account values accross their customer base. maybe i'm borrowing your unused money, or a foreign client's
timber hill probably has ways to hedge their credit risk throughout the day, and i'm sure (hope) they keep a close eye on things like var
any brokers out there, how are fx margins possible, solely from the revolving door and higher commissions?
i wonder where a broker like IB is comfortable keeping the total level of margin loans in relation to total account values accross their customer base. maybe i'm borrowing your unused money, or a foreign client's
timber hill probably has ways to hedge their credit risk throughout the day, and i'm sure (hope) they keep a close eye on things like var
any brokers out there, how are fx margins possible, solely from the revolving door and higher commissions?
yes I'm crazy: I'm the Fool of the King. There is no need to be brilliant when one just need common sense ... against the huge majority of imbecile crowd: nothing new since at least "Memoirs of Extraordinary Popular Delusions by Charles MacKay"
ftp://sunsite.unc.edu/pub/docs/books/gutenberg/etext96/ppdel10.txt
During the mississipi bubble who was the fool ?
"Marshal Villars, was so vexed to see the
folly which had smitten his countrymen, that he never could speak with
temper on the subject. Passing one day through the Place Vendome in
his carriage, the choleric gentleman was so annoyed at the infatuation
of the people, that he abruptly ordered his coachman to stop, and,
putting his head out of the carriage window, harangued them for full
half an hour on their "disgusting avarice." This was not a very wise
proceeding on his part. Hisses and shouts of laughter resounded from
every side, and jokes without number were aimed at him. There being at
last strong symptoms that something more tangible was flying through
the air in the direction of his head, Marshal was glad to drive on. He
never again repeated the experiment."
ftp://sunsite.unc.edu/pub/docs/books/gutenberg/etext96/ppdel10.txt
During the mississipi bubble who was the fool ?
"Marshal Villars, was so vexed to see the
folly which had smitten his countrymen, that he never could speak with
temper on the subject. Passing one day through the Place Vendome in
his carriage, the choleric gentleman was so annoyed at the infatuation
of the people, that he abruptly ordered his coachman to stop, and,
putting his head out of the carriage window, harangued them for full
half an hour on their "disgusting avarice." This was not a very wise
proceeding on his part. Hisses and shouts of laughter resounded from
every side, and jokes without number were aimed at him. There being at
last strong symptoms that something more tangible was flying through
the air in the direction of his head, Marshal was glad to drive on. He
never again repeated the experiment."
Quote from Lightningsmurf:
Jetheat,
Ignore Harrytrader for now - he's either brilliant or crazy, most of us haven't decided which, yet. Either way he'll probably just confuse you.
So far you've gotten a few replies that contradict each other a little because you haven't told us what you are trading. The nuances of leverage and market markers differ slightly whether you are dealing with equities, commodeties, futures, or spot-fx.
To answer your other question, the broker IS the market maker (in the case of retail fx). They take your orders and then trade against you - yup it's good to be the casino!
And it's even easier with modern communication to brainwash people than a few centuries ago ! Common sense is not so common and when it comes to financial sense it's even worst !
As Economist John Kenneth Galbraith put it
âThe study of money, above all other fields in economics, is one in which complexity is used to disguise the truth or to evade truth, not to reveal it.â ⦠John K. Galbraith
"Make the lie big enough, and tell it often enough, and people will believe it"
⦠Joseph Goebels, Hitler's Minister of Propaganda
as introduction to the excellent and humurous article by Jim Willie
http://www.financialsense.com/Market/willie/2004/0503.html
OREWELLIAN FINANCIAL NEWSPEAK
"The public is ripe for the deception, given its ignorance and illiteracy. One of my recorded charges is overt manipulation of the language itself. Special thanks are due to Jay Chen in Hong Kong for his contributions.
DECEPTIVE INDOCTRINATION OF ECONOMIC DEFINITIONS
Important terms and economic concepts must be redefined if we are to maintain a system whose foundation is built upon debt, whose commerce is dependent upon debt, and whose engines runs on debt leveraged to the extreme. The field of psychology has a technique called âframingâ to put the best face on a situation, to position a relationship in a position light, to promote constructive actions and healing. Our financial world has employed this tactic par excellence, with the full complicity of brokerage firms and banking leaders, assisted by the press & media, but with wicked motives. The public had to be schooled to accept debt as good, despite its long history of being a destructive agent. Public ignorance of most things mathematical and almost all things financial is critical. Rampant gullibility continues to this day, as bubbles have reinflated in a more grand fashion. Any one action alone would be insignificant. However, taken in their totality as a pattern, a case can be made for magnificent collusion and indoctrination.
âlegal tender is now moneyâ
Since the abandonment of the gold standard, money used inside the United States cannot pass any constitutional test. Explicit requirements are stated whereby gold and silver, or notes backed by these precious metals, are the only valid form of money. A $20 bill will surely enable you to purchase a batch of groceries, or fill your car tank with gasoline, or buy new clothes, or complete other sales. That does not mean the $20 bill constitutes money. We pay for things with money, or so we think. No. We pay with legal tender, some medium of exchange approved for brokering a transaction between two parties. In ancient times, it could have been salt. In colonial times, it could have been beaver pelts or wampum. At some progressive food coops, it could be vouchers. No, our USDollar is no longer money, and contains less tangible value than salt or pelts. It is denominated debt. The USDollar is no longer represented by gold reserves safely secured in Fort Knox or Federal Reserve Bank vaults. USDollars we spend are actually debt denominated coupons which are widely used to satisfy debts and obligations, public and private.
âcredit access is now wealthâ
Tell any person, young or middle aged or old, that he or she has a brand new credit line of $10 thousand. Stand back, watch the reaction. Now observe the ensuing talk. It is centered on what the person now plans to purchase. Especially within the USA, economic participants extend debts by drawing upon credit lines. They do it in force, with fanfare, vigor, and enthusiasm. A new credit line of size enables people to feel suddenly more wealthy, despite no change to net worth, i.e. wealth. Opportunity seems to spring up. Ideas flow. Dreams are pictured. Unfortunately, use of that credit line comes with an obligation to pay back money to the creditor. That hardly gets in the way of spending, for most people. In fact, a more perverse common thread exists. Some people actually harbor the notion that they can always declare bankruptcy if times get tough, if things go bad, if control is lost. Bankruptcy and restructured debt is commonplace. Among the ranks of college students, fully 23% have already declared bankruptcy, a shocking statistic. We as a culture have come full circle apart from our parents and grandparents. They learned of the ravages of debt destruction during the Great Depression. Our generation celebrates debt, and abuses it to unbelievable levels. It has thoroughly confused wealth and credit access.
âmonetary inflation is now liquidityâ
When financial markets come in danger of lockup, seizure, and danger of aggravated losses, we have come to depend upon our bank leaders to provide the necessary liquidity to prevent a crisis from building. When the Asian Meltdown circled the globe and finally hit Long Term Capital Management, we depended upon more liquidity to fix the problem. When the World Trade Center hit and the stock market was jolted, we depended upon more liquidity to restore order. When bankruptcies, both household and corporate, ran rampant in late 2000, we depended upon the extreme liquidity solutions escorted by rock-bottom interest rates to stimulate the economy into economic recovery. The USGovt serves as a capable partner in the process, with tax rebates, tax cuts, other tax reform, and pervasive stimulative spending. One could go so far as to say that the Iraqi War kick-started the US Economy in March 2003. Spending for military supplies through contractors provided ample liquidity which flowed into the economy. All this is naked inflation, disguised as stimulus, labeled as liquidity.
âfiscal bankruptcy is now federal stimulusâ
Former Treasury secretary OâNeill exposed the true nature of the full federal debt obligation. Federal deficits are rising at a greater than 10% annual pace. Operational funding requirements appear to be lessened after the confiscation of the Social Security Trust revenues incoming, another shell game. The Iraqi War exacerbates federal fiscal needs off the budget ledger. While the system is bankrupt, and getting worse by the year, we focus attention on federal stimulus. Most stimulus is regarded as constructive, in pursuit of a favorable outcome, with a stated purpose and goal. We have no clear purpose except to hide the bankruptcy and maintain inertia of the process.
As Economist John Kenneth Galbraith put it
âThe study of money, above all other fields in economics, is one in which complexity is used to disguise the truth or to evade truth, not to reveal it.â ⦠John K. Galbraith
"Make the lie big enough, and tell it often enough, and people will believe it"
⦠Joseph Goebels, Hitler's Minister of Propaganda
as introduction to the excellent and humurous article by Jim Willie
http://www.financialsense.com/Market/willie/2004/0503.html
OREWELLIAN FINANCIAL NEWSPEAK
"The public is ripe for the deception, given its ignorance and illiteracy. One of my recorded charges is overt manipulation of the language itself. Special thanks are due to Jay Chen in Hong Kong for his contributions.
DECEPTIVE INDOCTRINATION OF ECONOMIC DEFINITIONS
Important terms and economic concepts must be redefined if we are to maintain a system whose foundation is built upon debt, whose commerce is dependent upon debt, and whose engines runs on debt leveraged to the extreme. The field of psychology has a technique called âframingâ to put the best face on a situation, to position a relationship in a position light, to promote constructive actions and healing. Our financial world has employed this tactic par excellence, with the full complicity of brokerage firms and banking leaders, assisted by the press & media, but with wicked motives. The public had to be schooled to accept debt as good, despite its long history of being a destructive agent. Public ignorance of most things mathematical and almost all things financial is critical. Rampant gullibility continues to this day, as bubbles have reinflated in a more grand fashion. Any one action alone would be insignificant. However, taken in their totality as a pattern, a case can be made for magnificent collusion and indoctrination.
âlegal tender is now moneyâ
Since the abandonment of the gold standard, money used inside the United States cannot pass any constitutional test. Explicit requirements are stated whereby gold and silver, or notes backed by these precious metals, are the only valid form of money. A $20 bill will surely enable you to purchase a batch of groceries, or fill your car tank with gasoline, or buy new clothes, or complete other sales. That does not mean the $20 bill constitutes money. We pay for things with money, or so we think. No. We pay with legal tender, some medium of exchange approved for brokering a transaction between two parties. In ancient times, it could have been salt. In colonial times, it could have been beaver pelts or wampum. At some progressive food coops, it could be vouchers. No, our USDollar is no longer money, and contains less tangible value than salt or pelts. It is denominated debt. The USDollar is no longer represented by gold reserves safely secured in Fort Knox or Federal Reserve Bank vaults. USDollars we spend are actually debt denominated coupons which are widely used to satisfy debts and obligations, public and private.
âcredit access is now wealthâ
Tell any person, young or middle aged or old, that he or she has a brand new credit line of $10 thousand. Stand back, watch the reaction. Now observe the ensuing talk. It is centered on what the person now plans to purchase. Especially within the USA, economic participants extend debts by drawing upon credit lines. They do it in force, with fanfare, vigor, and enthusiasm. A new credit line of size enables people to feel suddenly more wealthy, despite no change to net worth, i.e. wealth. Opportunity seems to spring up. Ideas flow. Dreams are pictured. Unfortunately, use of that credit line comes with an obligation to pay back money to the creditor. That hardly gets in the way of spending, for most people. In fact, a more perverse common thread exists. Some people actually harbor the notion that they can always declare bankruptcy if times get tough, if things go bad, if control is lost. Bankruptcy and restructured debt is commonplace. Among the ranks of college students, fully 23% have already declared bankruptcy, a shocking statistic. We as a culture have come full circle apart from our parents and grandparents. They learned of the ravages of debt destruction during the Great Depression. Our generation celebrates debt, and abuses it to unbelievable levels. It has thoroughly confused wealth and credit access.
âmonetary inflation is now liquidityâ
When financial markets come in danger of lockup, seizure, and danger of aggravated losses, we have come to depend upon our bank leaders to provide the necessary liquidity to prevent a crisis from building. When the Asian Meltdown circled the globe and finally hit Long Term Capital Management, we depended upon more liquidity to fix the problem. When the World Trade Center hit and the stock market was jolted, we depended upon more liquidity to restore order. When bankruptcies, both household and corporate, ran rampant in late 2000, we depended upon the extreme liquidity solutions escorted by rock-bottom interest rates to stimulate the economy into economic recovery. The USGovt serves as a capable partner in the process, with tax rebates, tax cuts, other tax reform, and pervasive stimulative spending. One could go so far as to say that the Iraqi War kick-started the US Economy in March 2003. Spending for military supplies through contractors provided ample liquidity which flowed into the economy. All this is naked inflation, disguised as stimulus, labeled as liquidity.
âfiscal bankruptcy is now federal stimulusâ
Former Treasury secretary OâNeill exposed the true nature of the full federal debt obligation. Federal deficits are rising at a greater than 10% annual pace. Operational funding requirements appear to be lessened after the confiscation of the Social Security Trust revenues incoming, another shell game. The Iraqi War exacerbates federal fiscal needs off the budget ledger. While the system is bankrupt, and getting worse by the year, we focus attention on federal stimulus. Most stimulus is regarded as constructive, in pursuit of a favorable outcome, with a stated purpose and goal. We have no clear purpose except to hide the bankruptcy and maintain inertia of the process.
It's not an interest free loan. In the case of securities, you DO pay interest on your margin balance to the brokerage firm that carries your account. With futures, nothing actually changes hands prior to delivery, so there is no money borrowed, the margin is simply a performance bond. You have agreed, for instance, to deliver 5000 bushels of soybeans or $100,000 in Treasury Bonds at a given price at a given date in the future. If you close the position prior to that time, you do so at either a profit or loss, based on the price at that time. If you don't, you are obligated for delivery (depending on the contract, either physical goods or cash) at that time, and at the previously agreed price at which you purchased or sold the contract. Market makers are just individuals or firms who constantly buy and sell hoping to make small profits from the bid/ask spread along the way, while providing liquidity.
Jessie
Jessie
In essence yes, (with equities) but it's not risk free, and that is in part what you are really paying for. There have been large houses taken down by sudden gap moves that their customers couldn't cover. I don't (won't) trade the over-the-counter forex market, so I really don't know whether they charge interest on margin balances or not. They make a significant profit by "owning" the bid/ask spread, which is generally artificially large, and the fact that you will always have to pay it to them. In futures, there is no interest charged, in fact, you are typicaly paid interest on your margin balance, and the "house" makes its money solely from comissions, and can not trade directly against customer orders. Instead of dealing with one house for your transactions, you are free to try and split the bid ask spread , or buy at the bid/sell at the offer as you wish.
Jessie
Jessie