Trading Forex Without Leverage - Key Takeaways
- Forex is one of the most highly leveraged markets. For the majority of traders, this is essential since this lets them earn high payouts with smaller deposits and without the major changes in the exchange rates.
- Despite its popularity, there are a number of traders who might prefer not to use leverage in Forex. This category includes people with large trading accounts, part-time traders who are simply looking for a better return on savings, and those market participants who are aiming to gather real-time trading experience without taking much risk.
- No leverage trading in Forex can significantly reduce the risks, however, it does not eliminate them completely. Therefore, traders employing this strategy still need to do the proper fundamental and technical analysis of the market before opening positions.
FAQ: No Leverage FX Trading
How does the leverage in Forex differ from its use in the Stock Market and the Real Estate?
According to the US regulations before using leverage in the stock market, a client must make at least $2,000 investment to open a margin account, although there are some brokerage firms, which might require larger deposits. After the account is open, a trader can borrow up to 50% of each trade. For example, if an individual wants to purchase stock worth $100, her or she can borrow up to $50 for this transaction, however, as noted earlier, there is no leverage if the deposit is lower than $2,000. Therefore the effective maximum available leverage is 2:1.
One possible reason for such restrictions is the fact that highly leveraged stock market trading was one cause behind the 1929 great depression.
Investors leverage their real estate investments by borrowing from the bank against the given property. The exact conditions of each mortgage agreement can vary depending on the financial institution. However, the most common type of mortgage typically includes the investor's down payment of 20% and the bank lending the rest 80%. If the buyer of the property can not come up with 20%, then he or she might have to pay for mortgage insurance as well.
Therefore, we might conclude that in this 20/80 example, investors use 5:1 leverage, and such arrangements are very common in the real estate market.
Can a Forex day trading work without leverage?
Forex trading without leverage can work with any timeframe, including day trading. However, as mentioned before, a trader will most likely need to have a large amount of money in his or her trading account in order to earn significant payouts on a regular basis. So, if you're asking yourself, "can I trade Forex without leverage?" - yes, you can, but it will set you back a lot financially.
What are the average leverage amounts used by the traders at major US investment banks by the time of the 2008 Economic Crisis?
According to Larry McDonald, a former trader at Lehman Brothers, by 2004 the average leverage used by the company’s trading division was 20:1. However, over the next years, this was expanded significantly. As he mentioned, by the time of Lehman’s bankruptcy the average leverage had increased to 44:1.
According to the BBC documentary which features this interview, the main competitors of the firm, Goldman Sachs and Morgan Stanley have been more conservative in the borrowing, keeping the leverage ratio between 20:1 to 35:1. Therefore we might safely conclude that overleveraging one of the most important reasons for the bankruptcy of the Lehman Brothers.
What are regulatory limitations on the use of leverage in the Forex market in the US and EU countries?
According to the latest regulation, introduced by the European Securities and Markets Authority (ESMA) the leverage in EU is limited to 30:1 in the case of top tier securities, for example, Forex Majors, EUR/USD, USD/JPY and other currency pairs, 20:1 for Minor pairs and Gold, 10:1 for oil and other commodities, and 5:1 for Stocks.
In the US, the National Futures Association (NFA) enforces regulations, according to which the limit of maximum available leverage is set at 50:1 for the major currencies. According to the NFA, the major currencies are:
- British Pound
- US Dollar
- Australian Dollar
- Canadian Dollar
- New Zealand Dollar
- Japanese Yen
- Swedish Krona
- Danish Krone
- Norwegian Krone
The maximum leverage is limited to 20:1 for minor currencies. This decision was meant to protect the inexperienced traders from taking on massive risks with high levels of leverage.
What are some common mistakes in no leverage Forex trading?
One of the most common mistakes traders in general make is to ignore proper risk management rules, by using their entire deposit for one, two, or some other small number of trades. Even if a trader is not using any leverage, investing 50% or 100% of one’s trading capital towards one position can be very dangerous and could lead to massive losses and potentially wipe out the entire deposit. Can you trade Forex without leverage? Absolutely, but you need proper risk management framework to secure your funds.
Another common error is not limiting losses on time. Obviously, currency exchange rates usually do not go to zero, so with 1:1 leverage, it should be technically impossible to lose the entire deposit. However, by ignoring the above-mentioned risk management rule, a trader can still lose a significant portion of his or her trading capital. Therefore, when the market moves against the market participant, it is essential to close positions on time and cut potential losses.
So it is essential to keep in mind that although trading with low leverage can reduce risk, it does not eliminate it entirely and a trader still needs to take measures to protect his or her trading capital.