Where does Leverage come from?

Discussion in 'Professional Trading' started by Jetheat, May 12, 2004.

  1. Jetheat


    Just to get this straight in my head, I have a fundamental question.

    If we can buy 100k worth of currency on margin (deposit), who puts up the rest of the cash in order to allow the common man to trade large numbers?

    If the answer is "Market Maker", who the hell is that and what does he do?

    Appreciate some background on this,

  2. Most people think of margin as a kind of collateral, but depending on the instrument you are trading, it is more like a down payment.

    In the case of spot-fx the market maker is usually the person offering you the money. From their point of view it is a no lose situation. If you use most of your allowed margin (not a good idea) then they will clean out your account when/if the trade goes a little against you. Of course if you use tons of margin and the trade miraculaously works out, then you are laughing on your way to the bank.

    The bank/market-maker has little downside because they will cut off your trade as soon as they start to lose money. By offering you more money to work with you trade bigger and they make more commissions.

    The "market maker" is the guy that makes a market. When you send your order to a retail fx firm there is a "spread". In FX you mostly get a fill with little slippage, but you have to pay the spread. It's like using a market order on a stock - you pay the difference between the bid and ask.

    I'm not really sure how much you know or what your background is. I hope this helps. I'm sure others will add to it.

  3. Whoa, I didn't know that. Maybe I should get my date a bouquet of broccoli next time.:p
  4. leverage comes from credit -- a measure of the risk willing to be taken on someone. it's a fascinating tool.

    on the S&P headquarters in Manhattan is an inscription which calls credit the most powerful invention of a civilized society or something similar (it's worth reading) -- enabling the production of wealth on a scale impossible without it.

    seemed like a good thread to drop this in on.
  5. %%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%

    Good points Lightning -

    Of course if you use tons of margin Jetheat,you actually DECREASE the probability of a win or miracle win;
    using tons of margin actually DECREASES the probability of laughing all to the bank.

    Of course you may also notice the big trees that weigh tons;
    there is more probabibility of a lightening strike & the lightening always wins , not the trees that weigh tons.

    In a multitude of counselors ther is safety.
    Solomon, lightening observer & trader king.
  6. %%%%%%%%%%%%%%%%%%%%%%%%%%%%%

    See what you mean on S&P & wealth production;
    William O 'Neill of IBD does something like the more mature the bull market the less leverage he uses.:cool:
  7. jessie


    The answer is that YOU have actually agreed to put up the difference, and pledged your assets to do so, you just don't necessarily deposit it in your account at the time of the trade. Your required margin is just a small performance bond, but you are liable for the full amount at all times. If you are trading one contract of TY, for example, you are trading $100,000 even though the margin requirement is a fraction of that. You have agreed to be liable for the full amount of any losses incurred, not just your margin deposit. That is why most professional traders only risk 1-3% of available margin capital on any given trade.
  8. pspr


    Yeah, then you could use that famous line without getting in too much trouble:

    "Here, eat this!"

  9. Jetheat


    ok, I understand the leverage bit but I still don't understand who a market maker is.

    Is there a Market Maker at every broking firm?

    If so, do they guarantee the remaining money on your behalf? And if you start running short, they will close your position.

    Does the leverage have anything to do with interest?

    Appreciate some more help.

  10. http://www.users.cyberone.com.au/myers/money-masters.html

    " A $10,000 bond purchase by the Fed on the open market results in a $10,000 deposit to the bond seller's bank account. Under a 10% (i.e. fractional) reserve requirement, the bank need keep only $1,000 in reserve, and may lend out $9,000. This $9,000 is ordinarily deposited by the borrower in either the same bank or in other banks, which then must keep 10% ($900) reserve, and may lend out the other $8,100. This $8,100 is in turn deposited in banks, which must keep 10% ($810) in reserve, and then may lend out $7,290, and so on.

    Carried to the theoretical limits, the initial $10,000 created by the Fed, is deposited in numerous banks in the banking system, which gives rise (in roughly 20 repeated stages) to expansion of $90,000 in new loans, in addition to the $10,000 in reserves.

    In other words, the banking system, collectively, multiplies the $10,000 created by the

    {p. 11} Fed by a factor of 10. However, less than 1% of the banks create over 75% of this money. In other words, a handful of the largest Wall Street banks create money, as loans, literally by the hundred billion, charging interest on these loans, leaving crumbs for the rest of the banks to create. But because those crumbs represent billions too, the lesser bankers rarely grumble. Rather, they too support this corrupt system, with rare exceptions.

    In actual practice, due to numerous exceptions to the 10% reserve requirement, the banking system multiplies the Fed's money creation by several magnitudes over 10 times (e.g. the Fed requires only 3% reserves on deposits under c. $50 million, and no reserves on Eurodollars and nonpersonal time deposits).

    Thus the U.S. currency and bank reserve total of roughly $600 billion, supports a total debt structure in the U.S. of over $20 trillion in debt - roughly $80,000 in debt for every American, man, woman and child, which includes the national debt, bank debt, credit card debt, home mortgages, etc.

    The Fed created only roughly 3% of this total, private banks created roughly 97% (including intra-government debt). All of this could and should have been created by the U.S. government, without the parallel creation of an equivalent quantity of interest-bearing debt, over the years and used to pay for government expenditures, thus reducing taxes accordingly. "
    #10     May 12, 2004