Forex Leverage Regulation

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The retail forex market has long had significant leveraging allowances, but this has recently come under threat by FINRA, the largest independent securities regulator in the United States. Since the Internet retail forex boom, many forex brokers have been offering their clients anywhere from 50/1 to 400/1 leverage on their accounts. FINRA is claiming that the proposed change would serve to protect investors from excessive market risk.

This proposal, however, assumes that traders are not using leverage properly. Having leveraging capabilities isn’t tantamount to over-leveraging one’s positions, and this is what the FINRA proposal is failing to recognize; instead, leverage merely allows a trader to exercise exact risk management in relation to the size of their positions. For instance, if a trader wished to risk only 1% of their total capital per position, they would use leverage to determine the amount that they are willing to risk per pip, based on the size of their stop loss. Having leveraging capabilities allows a trader to dynamically adjust the size of their stop, so as to accommodate the current volatility levels of the market, while still maintaining a fixed position risk, regardless of whether they are risking 10 pips or 1000 pips.

Conversely, not having such leverage available will likely negatively impact traders who are using appropriate risk management. Reducing the leverage means that you will have less available margin for active positions, even if you are risking the same amount in both scenarios. This means that such traders are more likely to experience a margin call, assuming a consistent position risk, if the leveraging allowances were to be reduced

The most unpalatable part is that FINRA not only wants to limit the leverage – they evidently intend to practically eliminate it. If FINRA simply wanted to bring forex leveraging limits to the levels of commodity futures it would be far more understandable. Under the proposal, however, forex brokers would only be able to offer leverage of 1.5:1. Anyone who trades the forex markets knows that this would effectively put an end to US-based retail forex trading, since very few people would be able to properly trade under such a mandate. US-based FCMs would go out of business, and US-based traders would invest their money with oversees brokers.

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

For anyone that is worried about this, you can rest easy for the moment. As it thankfully turns out, FINRA does not have specific regulatory authority over the forex markets; that would increasingly be the domain of both the NFA and the CFTA, whose regulatory capacity is significantly expanding in forex. Further, it wouldn’t be in the interests of the NFA and CFTA to support this proposal, not to mention the flagrant inconsistency it would create with currency futures: they have been working long and hard to exact more control over the domestic forex market. If it were to predominately move oversees, they would have lost the ability to effectively regulate such activities (not to mention the membership fee revenue that they would receive from Forex CTAs).

Christopher Muir