Thanks, that's helpful. But I don't grok how he can trade €5,000 with only lunch money in his account. Does he have some other collateral with the broker?
Thats what you call "leverage", or trading on margin. It is the same in futures trading, currency trading, CFDs ... You buy or sell a financial contract, but you dont have to come up with the whole nominal value (in this case the 5,000 EUR) of the financial contract you are trading. You only have to deposit a much smaller amount (for example 20 EUR) in order to cover potential losses. Your broker knows that EURUSD wont drop to zero within a day, or at all. So he does not need you to finance the whole investment on your own. He only needs some kind of security margin, to cover the day to day volatility in the market you trade. The higher the volatility of your market, the higher the required margin. So basically the broker lets you play with 5,000 even if you dont deposit the whole sum because he knows it is impossible that the EURUSD drops to zero. He will only ask you to deposit as much as necessary to cover losses that are very probable based on the volatility of the instrument. Once in a while these assumptions go wrong (check for example the fun in the CHF in 2015), but it is kind of a tradeoff for the brokers. With lower margins there is higher risk both for the client and the broker, but on the other hand with low margins he can attract more clients and earn money on them until something blows up again. How much leverage a forex broker offers is pretty much up to him. Some are very aggressive and offer something like 400:1 (which means you only need 10 US$ to play with 4000 US$). Others are more conservative and offer leverages of 100:1 or 50:1. With futures it is similar, many retail brokers offers emini intraday margins of 500 US$, which is equal to to a leverage of about 265:1. Hope this helps a bit.
Thanks. I don't understand how brokers can offer 400:1. Suppose € pops 1% on an economic release or ECB comment?
That's how they clean out their customers' (I nearly said "victims' ") accounts. These are counterparty market-makers, not genuine brokers: they're incentivized for their "customers" to lose. Governments and regulators are very gradually clamping down on such high leverage - eventually it will doubtless be a thing of the past. In the US it's now limited by law to 1:50, and in Europe they're discussing/recommending a 1:30 maximum. High leverage in itself isn't dangerous in experienced hands, but the reality is that it tends to be used by the aspiring traders with the least experience and understanding, the most unrealistic expectations, and a gambling mentality, many of whom typically don't even appreciate the difference between a genuine broker and a counterparty, and what it signifies. In practice, there's a very high correlation in the industry between account leverage-levels and account blow-ups. These are "brokers" highly skilled at marketing, who know exactly how to attract the customers they want (ridiculously high leverage, gimmicks, deposit bonuses, competitions, etc. etc.), on whose persistent trading failures their own business model rests.
eurusd is not very volatile by stock market standards. it has a range of 40 pips daily so that i think that works out to .3% not sure can somebody do the math please
with 400 leverage a 0 .25% move against your position will wipe out your entire deposit. that is the meaning of leverage
It's really not quite as simple as that - you may be overlooking stop-losses (when they're honoured).