Reader Questions Answered

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.