Forex Leverage Regulation

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The retail forex market has long had large leverage allocations, but this has recently been threatened by FINRA, the largest independent securities regulator in the United States. Since the internet retail forex boom, many forex brokers have offered their clients 50/1 to 400/1 leverage on their accounts. FINRA says the proposed change would serve to protect investors against excessive market risk.

This proposition, however, assumes that traders are not using leverage properly. Having leverage capabilities doesn't equate to over-exploiting your positions, and that's what the FINRA proposal fails to recognize; instead, leverage simply allows a trader to exercise exact risk management based on the size of their positions. For example, if a trader wanted to risk only 1% of his total capital per position, he would use leverage to determine how much he is willing to risk per pip, based on the size of his. stop loss. Having leverage capabilities allows a trader to dynamically adjust the size of his stop, in order to adapt to current market volatility levels, while maintaining a fixed position risk, regardless of the makes him risk 10 pips or 1000 pips.

Conversely, not having such leverage will likely have a negative impact on traders who use proper risk management. Reducing leverage means you will have less margin available for active positions, even though you risk the same amount in both scenarios. This means that these traders are more likely to experience a margin call, assuming constant position risk, if leverage allocations were to be reduced.

The nastiest part is that FINRA doesn't just want to limit leverage – they obviously intend to virtually eliminate it. If FINRA simply wanted to bring currency leverage limits to commodity futures levels, that would be much more understandable. According to the proposal, however, forex brokers could only offer 1.5: 1 leverage. Anyone who trades in the forex markets knows that this would effectively put an end to state-based currency retailing. -United, because very few people would be able to negotiate properly under such a mandate. US-based FCMs would go bankrupt and US-based traders would invest their money with supervised brokers.

The FINRA proposal unfortunately appeals to the lowest common denominator: people who over-take advantage of positions with inappropriate stop-losses. In doing so, they consequently harm all traders who trade with proper risk management and simply use leverage as a necessary and responsible tool.

For anyone who is worried about this, you can rest easy for now. As it turns out fortunately, FINRA does not have a specific regulatory authority in the foreign exchange markets; this would increasingly be the domain of NFA and CFTA, whose regulatory capacity is developing considerably in forex. Also, it would not be in the interest of the NFA and the CFTA to support this proposal, let alone the glaring inconsistency it would create with currency futures: they are working for a long time and relentlessly to gain more control over the domestic foreign exchange market. If it were to relocate mostly supervisors, they would have lost the ability to effectively regulate these activities (not to mention the membership fee income they would receive from Forex CTAs).


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