If you are interested in trading on the Forex markets, one of the most important things to consider is the amount of leverage you seek to use. Essentially, when you are trading with leverage, you are borrowing money from a broker to open a larger position than what your deposited funds (or margin) allows you to. A leverage of 10:1 would mean that your deposited funds account for 10% of the value of the position being opened.
The view of leverage has changed in recent years – and the maximum available amounts of it have followed, with the majority of jurisdictions nowadays banning the provision of higher amounts. In this article, we will examine the pros and cons of high-leverage trading, as well as to why it is so heavily regulated nowadays:
High-leverage trading – high risk and high reward
Leveraged trading allows you to reap high profits, but it is also often described as a double-edged sword. A high leverage could mean enormous losses in the hands of the unprepared client, and trading with it can lead to many margin calls. This means that new traders should stick to lower amounts, and higher ones should be reserved for the more experienced client.
What we have described above is the modern understanding of leverage. However, this was not always the case. Forex trading was once restricted to large financial institutions, and the barrier to entry to it was extremely high. There was no need to keep the needs of the retail trader in mind, since no retail traders could access the markets. The advent of the internet changed this – the first FX trading platforms were introduced in 1996, with the oldest of them being iFOREX. Since then, retail clients were also able to make use of the markets, and the rest is history – the Forex market has reached a volume of $2.4 quadrillion in 2021.
However, a retail client is rarely as prepared to handle the incredible risks that come with high-leverage trading. Forex trading always involves risk and not even professional traders are always able to tell which way the markets will swing. There were extensive losses that were suffered by the retail trader, so measures had to be taken.
The US limits maximum leverage and sets the course for the world
In 2010, the United States restricted the leverage available to the retail client to up to 1:50. This restriction was conducted by the regulatory bodies in the country – the CFTC and the NFA. This leverage, however, was still deemed to be too high for all asset classes. Only Forex majors, currency pairs like the EURUSD were to be traded with the 1:50 leverage. The maximum amount available for CFDs with FX minors was set to 1:20 and lower leverage amounts were deemed appropriate for stocks and futures.
The original intent of the CFTC was to restrict leverage even further and to get it as low as 1:10. However, a large public outcry in the country at the time reversed these plans and the restriction of up to 1:50 was implemented. This policy has been going on strong for many years – in fact, 12 years later, the CFTC has not changed it and the maximum leverage is still as high.
The majority of the world began restricting leverage after the US – in 2018, the European Securities and Markets Authority, ESMA, revealed its plans of also reducing the maximum leverage available to the retail client. The EU restrictions were a bit stricter, with FX majors being allowed a leverage of up to 1:30. Minors have a cap of 1:20 and stocks have one of 1:5. The EU cap for crypto assets is even lower, as it sits around 1:5.
But even countries outside of Europe and the States restrict their leverage – Japan has had a cap on the available amounts for as long as the States. What’s more, this cap has been getting smaller and smaller – initially, amounts of up to 1:50 were available, but Japan has since reduced that to 1:25. In 2017 it was even considered for a cap of up to 1:10 to be imposed.
The most recent major market to join the restrictions on leveraged trading was the Australian one. Historically, the regulatory body there has been pretty reluctant to restrict the leverage amounts available to the retail client. This changed in 2020 with the Covid 19 pandemic. During it, the amount of retail traders on the Forex markets grew significantly. This led the ASIC – the Australian Securities and Investments Commission to significantly tighten its control over the markets, and put in place restrictions that are in line with the EU policies.
This denotes the continued evolution in the regulators’ understanding of high-leverage trading being a rather dangerous way for the retail trader to interact with the market – and we can only expect more and more countries to recognize and limit the available amounts in the future.
High-leverage trading is still around, it is just less accessible
All that said, it would not be true to say that high-leverage trading is gone nowadays. Indeed, it is still available to many clients – there are jurisdictions that have not restricted the leverage amounts available to the retail trader and local forex brokers offer leverage of 1:500 or even higher.
These are typically offshore or third-world countries and there are some risks involved with trading on their markets. They lie in the fact that the less strict regulation means there are less guarantees for the longevity of the brokers that offer high-leverage trading. In fact, a lot of them go under due to a lack of funds. There is also a worrisome trend of offshore scammers offering high-leverage trading to their clients and then simply stealing their deposits.
The safest way to trade with a high leverage is for you to make use of the client categorization policies of the regulatory bodies that restrict it. Most of them have some way for the brokers they license to offer higher amounts to traders – provided that the clients who access it are well enough equipped to handle the volatile markets.
For example, the strict regulation in the EU still allows for clients to access leverage higher than 1:30. They need to opt in to be categorized as a professional trader – this means complying with a set of criteria the EU has set. For example, they need to have a portfolio of over €500 000, possess significant knowledge or expertise in trading or have opened a certain volume of trades. Once two of the three criteria are met, the client will be able to qualify for a professional client status and make use of the higher leverage. However, this also means them losing some of the protections the EU countries have in place, like the access to guarantee funds.
High-leverage trading can propel your profits or tank your balance – we hope this article has managed to help you decide whether this kind of trading is for you.
Disclaimer: This content does not necessarily represent the views of IWB.