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.
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 More debt from the broker to the client means more risk that the money cannot be withdrawn.
Things become more complicated in case of various tricks. Here is an example from an article by Victor Golovtchenko on Finance Magnates:
Consider this: you and your spouse open two accounts in June of 2014, both of you get a bonus and you take different directions on the market. One is long the EUR/USD, the other is short the EUR/USD. Both of the accounts utilize substantial margin levels.
In the case of the EUR/USD move last year, a person who opened a 1,000,000 position which is warranted with a 2,000 EUR (assuming the leverage is 1:500) in the account could face two outcomes – losing those 2,000 EUR and the remaining principle on the account if the trader was long EUR/USD, or gaining $1,500,000 by December (assuming you entered at 1.35 and closed at 1.20).
Is going in opposite directions with your spouse or a friend legitimate? The answer does not really matter. Even if you do not play this kind of trick but your broker has to deal with these kind of moves and deny withdrawals, do you want to trade with a broker that deals with such things? Do you want to park your money with a broker that denies withdrawals?
Lack of Regulation
A broker offering an extreme leverage is probably not regulated or regulated in a forgiving jurisdiction. Strong regulatory bodies don’t allow high leverage. A lax environment means potentially less protection in case of dispute. A reputable regulator does not provide 100% safety as we’ve seen in several cases, but the chances of trouble are lower.
If you are trying to take advantage of leverage or bonuses, even if done in the most legitimate manner, you may run into trouble with the broker and finding remedy from the authorities will be an uphill struggle.
There can certainly be 100% honest brokers who offer high leverage to those wanting to take the risk and bonuses which are provided according to clear guidelines, where withdrawals are always instant.
However, high leverage poses risk to the brokers, and when they are at risk, you are at risk.
Do you have any experience with a broker suffering from some kind of leverage hangover? Do you have experience with a broker denying withdrawals? I’d love to hear your comments in the comment section below.Get the 5 most predictable currency pairs