Forex leverage regulation

The retail currency market has long had significant leverage quotas, but this was recently threatened by FINRA, the largest independent securities regulator in the United States. Following the boom in online retail, many forex brokers are offering their clients anywhere from 50/1 to 400/1 leverage on their accounts. FINRA claims that the proposed change will serve to protect investors from excessive market risk.

However, this proposal suggests that traders are not using leverage properly. The availability of leverage opportunities does not amount to an overuse of positions, and this is what FINRA’s proposal fails to recognize; instead, leverage simply allows the trader to exercise precise risk management in relation to the size of its positions. For example, if a trader wants to risk only 1% of his total equity on a position, he would use leverage to determine the amount he is willing to risk for pips based on the amount of their stop loss. The availability of leverage options allows the trader to dynamically adjust the size of his stop so as to comply with current levels of market volatility, while maintaining a risk of a fixed position, whether he risks 10 pips or 1000 pips.

Conversely, the lack of such leverage is likely to adversely affect traders who use appropriate risk management. Reducing leverage means you will have less margin available for active positions, even if you risk the same amount in both scenarios. This means that such traders are more likely to experience a margin claim by assuming constant position risk if leverage quotas are to be reduced

The most unpleasant part is that FINRA not only wants to limit leverage – they obviously intend to eliminate it in practice. If FINRA simply wanted to impose restrictions on forex leverage at commodity futures levels, this would be much more understandable. According to the proposal, however, forex brokers will be able to offer only 1.5: 1 leverage. Anyone who trades in foreign exchange markets knows that this would effectively put an end to US-based foreign exchange retail, as very few people could trade properly under such a mandate. US-based FCMs will go out of business, and US-based traders will invest their money in supervisory brokers.

FINRA’s proposal unfortunately appeals to the lowest common denominator: people who exceed their positions with inappropriate stop losses. In doing so, they therefore hurt 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 the moment. As it turns out, fortunately, FINRA does not have a specific regulatory body on foreign exchange markets; this will increasingly be the domain of both the NFA and the CFTA, whose regulatory capacity is expanding significantly in the currency. Furthermore, it would not be in the interest of the NFA and the CFTA to support this proposal, let alone the apparent inconsistency it would create with currency futures: they are working long and hard to gain more control over the internal currency market. If the supervisors moved mainly, they would lose their ability to effectively regulate such activities (not to mention the membership fee income they would receive from the Forex CTA).