Leverage Trick

Discussion in 'Forex' started by Mahmoud, Aug 26, 2006.

  1. Mahmoud


    Hi, I a new to FOREX.
    I understand that most of the Forex brokers give 100:1 leverage.
    I understand that means my $1K trade will be leveraged to $100K.
    Is there interest would i pay?
    What is the catch?
  2. Whenever you make a forex trade, you're selling one currency and buying another (i.e., if you go long on the USD/JPY pair you're buying dollars and selling yen). You receive the leveraged interest on the currency you buy (the dollar in our example) and pay leveraged interest on the currency you sell (the yen).

    If the short-term rate for the currency on which you're earning interest is greater than the short-rate for the currency on which you're paying interest, then you have a net gain just on the interest rate differential. The interest rate differential between the USD and JPY is currently a little less than 4.5 percentage points (i.e., the USD has a higher short-term rate), which would net you around $12 per day on a $100,000 lot. A currency position taken primarily to earn the interest rate differential is called an interest carry trade. Interest rate differentials are reflected in the difference between currency futures prices and spot forex prices (called the premium or cost of carry).

    A google search on "interest rate differential" or "interest carry trade" will give you a lot more information on this topic.

  3. Mahmoud


    I am not sure if i understand you correctly.
    I do not want to to trade in short-position.
    What i want to know.
    Why the brokers give such 100 leverage which make may $1K trade virtually make $100K trade ? what the catch ? Do Brokers befit from that ?
    Thanks fro your reply
  4. sim03


    The dealer benefits from greater income from spreads and/or commissions. Oh, and higher leverage - but only if you choose to bite - dramatically raises the odds that your $1K will somehow find a way to escape your account's Pluto-weak gravitational field, never to be seen again.

  5. Mahmoud


    Thanks sim03,
    So, the broker not applying interset cahrges on those leverage.
    the broker gets the profit as you said "spreads and/or commissions"
  6. Mahmoud,

    Perhaps the dealer/marketmaker hedges your trades and receives or pays interest concurrently with you, but at a different level.

    They make money on everything.

    Example you go long AUD/JPY...they go long AUD/JPY they pay your 2/3rds of the interest they make.

    Interest paid and interest received is passed on to you on the leveraged amounts.

    One of them even count it second by second...

    Michael B.
  7. sim03


    Not sure what you mean by the "not applying interest on leverage" part. Ignoring interest-free (Muslim) accounts, a forex dealer will always apply interest debit and credit to the 2 sides of the actual trade - whatever its leverage, if any.

    Take a closer look at the detailed explanation by JangoFolly above. For example, if you're long 100,000 USD/JPY, you'll be paid about $4,500 annually (at today's rates), which is 4.5% of $100,000. It also works out to 450% annual return on your $1,000 margin. Note that 450 = 4.5 x 100, where 100 is precisely your chosen leverage on that trade.

    Of course, in practical terms, you can't put on a 1-lot USD/JPY trade with $1K margin, on an account with 100:1 maximum leverage. The bid/ask spread alone, if not the normal volatility, will most likely immediately trigger a margin call. Goodbye, Pluto...
  8. Mahmoud


    Thanks, I got it.
  9. Mahmoud


    I tried your advice. I got more information about ïnterset carry trade". It was ver useful idea

    Still got a question.

    From where the broker will get the trade 100 leverage ?

    The broker hedges from other clients' accounts ?
    Or the broker hedges from external finicial instute?
    Or the broker make a short-term loan from whomever?

    If so for how much time does the broker hedge or loan the leverage money?