The Dangers of High Leverage, Even if You Don't Use High Leverage

01/29/2016 9:00 am EST

Focus: FOREX

For the benefit of all traders in the realm of forex, regardless of whether they use high leverage or not, Yohay Elam of ForexCrunch.com warns of the risk still present if the broker is offering a very high leverage and if the bonuses are also of a fantastic magnitude.

You don’t have to use to use high leverage in order to be exposed to the dangers of high leverage: if your broker is offering a very high leverage, of 200, 400, 500 or even 1000, this could serve as a warning sign. And if the bonuses are also of a fantastic magnitude, that could serve as a warning sign as well.

In some jurisdictions, leverage is limited to 100:1, 50:1, or even lower. This should be more than enough and many traders don’t pass the 10:1 leverage level. Needless to say, a high leverage offers great opportunity together with a quick way to wipe out your account (especially with high volatility) but that’s not what I want to focus on. Let’s say you are successful with high leverage or you’re not using the leverage offered. If your broker still offers that kind of leverage, the risk is still there.

Why?

The broker is at risk.

Let’s say you are successful on a specific trade and perhaps you’re not the only one. If the broker relied on its market maker mechanism to balance out the orders, did not manage the risk, and did not work properly with its liquidity providers, a few over-leveraged trades that all go in one direction in favor of the clients simply put the broker at risk.

There are still some brokers out there that never pass the orders to the liquidity providers and just wait for the novice forex trader to burn the account, pocketing the deposit of the trader as a profit. But when this does not materialize, there is material risk. The more serious brokers either properly manage risk: when they see that everybody is short EUR/USD, they do not assume the risk. Other brokers have an ECN/STP model where they are truly only brokers between the traders and the market, not assuming any risk at all. But in case of a big move, some accounts are wiped out but others can become bloated, with the clients claiming money that is not readily available.

Imagine a bank that suddenly shows the net worth of the accounts multiplied by 100 and the clients lining up to withdraw their newly found treasure. The cash might not be there. This is similar to group of highly leveraged traders that got it right on a trade without the broker handling the risk properly.

Compounding with Bonuses and Tricks

If, in addition to extremely high leverage, the broker also offers bonuses, this adds to the pressure in case of a winning trader. More debt from the broker to the client means more risk that the money cannot be withdrawn. To read the entire article click here…

By Yohay Elam, Founder, Writer, and Editor, ForexCrunch.com

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