Leverage in Forex trading is a rather controversial topic. It is a tool that can help you rake in massive profits or cause you to burn your deposited money. This is by design – leverage allows you to “borrow” money from the broker to open larger positions than you normally would be able to. If it is offering a leverage of 1:500 and you place an order with $10, you would actually be putting $50 000 on the line. And, as you can imagine, a change in the price of one of the assets, as small as them losing a cent in value could lead to you profiting or losing much more than if you had actually placed $10.
High leverage can therefore lead to what is known as a margin call. Brokers demand a certain amount of free capital be kept to cover potential losses – this is called free margin, and its size will depend on the size of the order you have placed. However, a significant dip, or a sharp rise, in the price of an asset will lead to the free margin being used up, and you could even end up in the negative! This is why you should think twice before engaging with high leverage, and putting yourself at risk of burning through your funds. Luckily, there are restriction on leverage around the world that are getting more and more common. Here are the reasons why these restrictions are getting more and more common.
Leverage restrictions around the world
US and Japanese restrictions kick off the trend of limiting leverage in 2012
First and foremost, there is a lot of jurisdictions nowadays that restrict the amount of leverage available to the retail client. The first countries to do so were the United States and Japan, which have had leverage restrictions for as long as a decade at the time of writing. These restrictions have been quite severe – the US brokers, for instance, have been limited to offering a leverage of up to 1:50 for FX majors, and companies in Japan have an obligation to not offer a leverage higher than 1:25 for the assets, to retail clients.
However, both Japan and the US have remained a strong Forex trading hub despite the regulation. This means retail clients in the countries have been able to adapt to the change and make the most of it, no matter the severity of the restriction.
EU enacts a common regulatory framework which restricts leverage in 2018
The limits on leverage were not commonplace around the world until about 2018, when the EU introduced a new set of rules for Forex trading. These rules came into force for every member-state, and a leverage restriction of up to 1:30 was allowed for the retail client in each state.
What’s more, this amount of leverage is only available for FX majors – more volatile assets, like crypto have lower amounts available – up to 1:2.
A largely influential policy the EU entered into force was the requirement for brokers to maintain a Negative Balance policy towards their retail clients. This policy makes it impossible for any of them to lose more money than what they have invested with a broker in the first place – this way, in a margin call, EU retail clients would not end up owing the broker a thing.
At the time of the measures being introduced, there was a panic among brokers in the EU. They thought a loss of clients and a significant lowering of trading volumes would occur due to the new rules in place. However, that has not really been the case – once the brokers adapted, the EU client has proven to be quite fond of Forex trading, no matter the leverage!
The lessons learned from the ASIC intervention in 2021 and the future of leverage
The most recent major jurisdiction to limit the exposure of retail clients to high leverage was Australia. The land down under was a home to many forex brokers offering 1:500 leverage. This was done via a product intervention of the regulatory body of the country – the ASIC, which took place in 2021. Australia had been reluctant to regulate its markets as strictly as the EU and the States had done, but that changed due to the regulator noticing the extreme losses by retail clients. Considering the Covid 19 crisis pushed more of these clients than ever to becoming FX traders, the ASIC decided it was time to enact a policy as strict as the one in the EU.
To that end, the maximum available leverage in Australia nowadays is 1:30 and a Negative Balance policy is also in place – following the regulation in the EU. These measures were entered temporarily by the ASIC – but their effects have already bore fruit, as the ASIC has released data on the effectiveness of the measure. According to it, the aggregate losses by retail clients have dropped by 91% since the measures entered into effect last year. The ASIC has extended the measures to five years, till 2027.
It seems this is the future of leverage – it is now strictly regulated in all major jurisdictions, and only offshore countries still lack any kind of formal provisions to regulate the amounts available to the retail client. It seems quite possible that the high leverage a generation of traders have grown accustomed to are a thing of the past. Given the drastic reduction in losses the ASIC noted for retail clients, this is certainly for the best as well.
So, who needs a leverage of up to 1:500 and who should avoid it?
As regulation becomes stricter, the access to high leverage is getting more and more difficult. However, the clients that know how to utilize it will still be able to make the most of their deposits with higher leverage amounts, even in stricter jurisdictions like the EU.
The regulatory bodies of these jurisdictions have left a certain door to high leverage via their client categorization policy. This means clients are divided in several groups based on their ability to handle the risks associated with trading on the Forex markets. This ability is judged by several statistics – there are several requirements in place that need to be fulfilled for a trader to get categorized as a professional.
There is the requirement for them to have a certain amount of trading experience, or to be a person with a background in economics. They need to transact a certain amount of trades and volume to be categorized too. Once they have proven their knowledge and ability to mitigate risk, they are allowed to trade with higher leverage by being granted the rank of a professional client. This is a good compromise between banning high leverage altogether and allowing the retail client to suffer consequences of engaging in too high of a risk!