01 September 2016

Finding the Right Broker: Leverage and Trade Size

Choosing a broker for a first time trader can be a daunting task. A lot of brokers offer similar products, with a core based around Forex, Indices, Commodities and Stocks. Mostly these brokers will offer CFDs, but some brokers may offer Spreadbetting services, depending on location.

Both of these kinds of accounts allow high leverage. Generally, the top leverage, which will usually be for Forex, can be 200:1. However, it is also possible to see leverage of 400:1 and higher, even as high as 1000:1 (maximum leverage has since been restricted in a number of regions). Increasing leverage increases risk, as highly leveraged accounts are exactly what they sound, if the market turns against the trader, then the higher the leverage the more of the trader's account can potentially be exposed.

One way to protect is to use a stop-loss. However brokers will not necessarily guarantee stop-losses, and losses can be so great relative to the account size that they can exceed the account balance. Some brokers will guarantee stop-losses, either for a fee or for free. If a stop-loss is not used then a position can be exited by the trader, but sometimes in leveraged trading the market can move very quickly by quite sizeable amounts, cutting into a leveraged account.

What leverage can provide as well as risk, is flexibility as larger positions can be held than the account size would otherwise allow, as well as unlocking assets for traders with smaller account sizes. But it can be the case that overly leveraged trading may be an uncomfortable experience for the trader, since moves against the direction of the trade will, relative to the account size, increment by large amounts. For example, an account with high leverage used to control mini lots with an account size which is more suited to micro lot trading, will rapidly become depleted in moves against the trade.

In Forex, it can be expected that moves may move against the trade, even if they then proceed to move in the chosen direction. Highly leveraged trades make riding out such moves difficult if not impossible and magnify fluctuations against the chosen direction to create this uncomfortable and risky trading experience. So matching account size to lot size can be a useful precursor to making use of leverage and turning it into a tool for flexibility and access.