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Why do market makers supply so significant leverage? Given that a substantial percentage of forex traders lose money, do these brokers take advantage of the traders’ risk? Or do brokers route orders through the interbank network and profit from spreads?
There are several sorts of brokers, and the quick answer is to utilise regulated brokers. There is a decreased possibility that the broker will work against the trader – and at least someone to complain to in such a circumstance.
The fuller answer – while not exhaustive of all brokers – is that some move orders to the interbank network while others do not. Intermediaries are those who pass all orders to the network and make money from spreads and occasionally fees charged to users.
Orders from various merchants may be matched by market makers. For example, if one person goes short on EUR/USD and another goes long, both with the same amount, the orders balance each other out. There is no need to send the order to the interbank market in this scenario.
When the equilibrium is upset
The issue emerges when the balance substantially shifts and everyone moves in one direction, and the broker fails to transfer the orders to the interbank network. In such instance, the broker is effectively pitted against its clients, creating a potentially dangerous conflict of interest.
Brokers relied on the Swiss National Bank’s guarantee to keep the 1.20 floor under 1.20 in the infamous instance of the “SNBomb” in January 2015. The EUR/CHF fell after the SNB abruptly removed the peg. As a result, some brokers went bankrupt.
Even under normal circumstances, the previously described conflict of interest is troublesome. To begin, if all of the traders place the correct bet and the broker does not cover, there is a danger for both the broker and the traders – being unable to withdraw cash.
Second, it implies that these brokers believe that the majority of traders would not only lose money, but will also completely liquidate their accounts. In such scenarios, the brokers’ revenue is derived from the traders’ deposits rather than spreads — practically everyone would liquidate their accounts.
The good, the bad, and the ugly of leverage
Leverage is a method used to make money by all sorts of traders, investors, and institutions. There is nothing intrinsically wrong with leverage since it permits markets to operate at a quicker pace. Even in the most stringent jurisdictions, the most careful banks employ leverage to protect themselves against larger loans by keeping just a modest amount of deposits.
People who take out mortgages leverage a little downpayment to purchase a property, and the majority of them pay down their obligations.
The issue arises when leverage becomes enormous, transforming a minor deal into a large wager.
Leverage levels in the triple digits are unquestionably high, and some brokers take advantage of the urge to invest only $1,000 to make a $100,000 deal. This can have disastrous effects because the possibility to make huge gains also implies a high likelihood of the account being destroyed.
When an account disappears suddenly, not only is the money gone, but so does the lesson.
It is the trader’s obligation not to utilise excessive leverage, even if the broker offers it. More realistic levels should be employed, which will result in fewer earnings – but a greater opportunity of learning from bad trades before terminating the account.
Some brokers attempt to persuade traders to utilise excessive leverage. It is the trader’s obligation to utilise less leverage or move to a different broker if they believe their trading activities are dangerous. To return to the beginning, the recommended practises are to trade with a registered broker and to use modest leverage, especially during periods of high liquidity.