The retail forex market has long had significant leverage allocations, but has recently been threatened by FINRA, the largest independent securities regulator in the United States. Since the rise of internet forex retail, many forex brokers have been offering their clients 50/1 to 400/1 leverage on their accounts. FINRA claims that the proposed change would serve to protect investors from excessive market risk.
This proposal, however, assumes that traders are not using leverage correctly. Having leverage capabilities is not the same as over-leveraging one’s own positions, and this is what the FINRA proposal does not recognize; instead, leverage simply allows a trader to exercise exact risk management relative to the size of his or her positions. For example, if a trader wanted to risk only 1% of his total capital per position, he would use leverage to determine the amount he is willing to risk per pip, based on the size of his stop loss. Having leverage capabilities allows a trader to dynamically adjust their stop size, to suit current levels of market volatility, while maintaining a fixed position risk, regardless of whether they are risking 10 pips or 1000 pips.
Conversely, not having such leverage available will likely negatively affect traders who use proper risk management. Reducing leverage means that you will have less margin available for active positions, even if you are risking the same amount in both scenarios. This means that such traders are more likely to experience a margin call, assuming constant position risk, if leverage allowances were to be reduced.
The nastiest part is that FINRA not only wants to limit leverage, they clearly intend to virtually eliminate it. If FINRA simply wanted to push FX leverage limits to commodity futures levels, that would be much more understandable. However, under the proposal, forex brokers could only offer 1.5:1 leverage. Anyone who trades the forex markets knows that this would effectively put an end to retail forex trading in the US, as very few people would be able to trade properly under such a mandate. US based FCMs would go out of business and US based traders would invest their money with offshore brokers.
FINRA’s proposal unfortunately appeals to the lowest common denominator: people who over-leverage positions with inappropriate stop-loss. By doing so, they do a disservice to all traders who trade with proper risk management and simply use leverage as a necessary and responsible tool.
For anyone who is concerned about this, you can rest easy for now. Fortunately, FINRA does not have a specific regulatory authority over the foreign exchange markets; that would increasingly be the domain of both the NFA and CFTA, whose regulatory capacity is expanding significantly in forex. Furthermore, it would not be in the interests of the NFA and CFTA to support this proposal, not to mention the glaring inconsistency it would create with currency futures: they have been working long and hard to exert greater control over the domestic currency market. If supervisors were predominantly moved, they would have lost the ability to effectively regulate such activities (not to mention the membership fee income they would receive from Forex CTAs).
