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How can forex brokers provide so much leverage?

Margin and leverage in trading are topics that cause a great deal of confusion to new traders. I received yet another question in that area recently, though with a bit of a different twist to it.

On the relationship between leverage and margin: I read that traders borrow money in margin account. In stocks, like in Malaysia, usually the brokerage firm is a subdivision of a bank, so it is the bank who lend the money. But in forex, who actually lend the money? Is it the broker? Does that mean, the broker is really really rich (like, if min leverage is 1:100, so it must have at least 100 times of the deposits of their clients.)?

As this individual noted, in stock trading the institution through which you are trading lends you the money to buy stocks on margin. Generally speaking that means you will have to pay them interest on that loan.

In forex trading things are a bit different. On the one side you are borrowing the currency you are short. That is then converted into the currency you are long, which is then deposited. In all of this you are paying an overnight interest rate on the currency you borrow (are short) and receiving an overnight rate on the currency you deposit (are long). The difference between the two is the net interest carry you will pay or receive.

Now, as to whether the broker is really rich to be able to over this kind of leverage, no. They do have considerable capital (the larger ones have over $100 million in capital), but not the amount I think this person has in mind. Why? Because they are mostly netting out customer positions against each other.

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Reader Questions Answered

Picking a Broker

I got this broker question the other day.

The single most important question would be what broker do you use to trade your personal money(not a demo account)?  Secondly who would be someone there to contact you personally deal with?

For stocks and options I still have the original brokerage account I opened lo these many years ago. That’s with Charles Schwab. I’ve never seriously looked at anyone else because I’ve been satisfied with the service and all of that, so I was never motivated to make a switch. I’ve heard good things about others, but as I haven’t personally explored them yet myself, I do not feel comfortable commenting on them.

On the futures side, I currently trade with PFG Best. In the past I have used Lind Waldock and Interactive Brokers. I’ve been satisfied with all of them, though they will all appeal to different types of traders.

In forex I experimented with several different brokers before ending up with Oanda. I also use them exclusively in my trading education work. They are considerably different from other forex brokers in that they have no fixed lots or minimums of any kind.

I do not have personal contacts at any of the above brokerages except at PFG Best. In that case, however, my contact has move out of futures.

All the above said, I do not specifically recommend any of the above brokers for any given person. Each of us has different needs which some brokers address better than others. You should absolutely do your research and not just take my or anyone else’s advice without looking into things yourself.

One final note. Especially in the forex realm there is a lot of slamming of brokers on forum sites and whatnot. Some of it is legitimate, but if you just go by that stuff you’ll be scared of every broker out there. Keep in mind that people have a strong tendency to complain rather than praise and traders who have lost money are prone to wanting to place blame on someone other than themselves. In other words, take it all with a grain of salt.