Leverage means making an investment in a transaction that is many times larger than the main amount of investment; thus, depending on the leverage ratio, it could lead to either profit or loss.
There are many brokers who provide their clients with the option of taking part in huge trades in the foreign currency market through provision of high leverage ratios like 1:50, 1:200, 1:500, etc. For instance, the leverage ratio of 1:100 provided by a broker to clients constitutes that in this market the client could, as a form of credit, trade 100 times more than their asset value.
The significant question is if providing a high leverage ratio to customers has any advantages?
Although the use of high leverage rations implies that the clients need to have smaller initial asset, it also increases the risk of losses accordingly. In order to better comprehend this issue, founders of FOREXer Company have collected some valuable documented reports on the ratio of losers to profit-makers in a number of large broker companies in the US. The following figures shown in recent years, on average 70 percent of clients have endured losses and 30 percent have made profits. These reports pertain to 4 quarters. It should also be mentioned that since 2011, all brokers that are under supervision of NFA in the US are required to limit their leverage ratio to a maximum of 1:50.
This implies that when a client opens a trade account with an American broker, they can carry a new transaction that at most is 50 times higher than their capital.
The following reports are from www.Forexmagnates.com
The following figure shows the total percentage of losers between the last quarter of 2009 and the first quarter of 2013 in large American broker companies. As it could be seen, a few months after approving the 1:50 leverage rule by the CFTC, the number of losers has decreased about 5 percent.
The figure below shows the ratio of total losers to profit-makers between the last quarter of 2009 and the first quarter of 2013 in large American broker companies.
In September 10, 2010, CFTC proposed to its brokers certain rules in order to decrease leverage ratio to a maximum of 1:10. Eventually, the leverage ratio of 1:50 was approved and has been implemented since October 18, 2010.
As the result of this rule, as it could be seen in the figures above, there has been a significant decrease in the amount of endured losses. However, the number of losers is on the whole still large.
The following figure shows the number of trade accounts has decreased as much as 25 percent, thus being indicative of the interest on the part of about 25 percent of the traders to use high leverage ratios despite repeated and frequent losses.
Therefore, in order to reduce customer losses, founders of FOREXer have adopted the 1:10 leverage ratio.
Another report prepared by an anonymous Forex broker deals with the trades after 2011. This broker provides the leverage ratio of 1:200 to clients.
For those who believe they do not want a broker to control them and they could use stop loss to control their risks, it could be said that: Maintaining assets and survival are the most significant goals in financial markets; hence, it is necessary to avoid the potential risks that could decrease or destroy assets. In addition, obtaining information and using past experiences as well as the experiences of the successful people should be priorities.
Many brokers have lost all their capital because of feeling that there is nothing for them to learn, thus leaving the market with a bitter experience.
Because of being in high-risk, and sometimes new, environments, traders are always prone to showing unusual behaviors that they have never experienced before and are even unaware of having such tendencies in their nature.
The significance of psychological factors in financial markets in so large that having complete commandment of the market or not observing the rules that govern the market could become a strong hurdle for being successful in efficiently explore the market. The two key factors of “using high leverage ratio” and “psychological factors” are among the factors affecting the performance of traders and therefore play important roles in traders’ loss or gain.
The above report investigates the use of high leverage ratio. Psychological factors and their significant effect on actions and reactions of traders in different conditions of the market are to be discussed here: Psychological factors pertaining to traders’ loss: There are certain natural features in each person that require particular conditions and circumstances to emerge. For instance, the sense of greed or fear exists in almost all people, but preventive environmental factors stop people to show or even know about them. Since the sense of evading law is another potential feature of human beings that is being controlled in societies by external forces (like social rules and regulations), traders tend to reveal their internal feelings when they enter a market in which such preventive forces are absent, trying to respond to their suppressed feelings.
The following factors are among the psychological factors that unconsciously emerge in sensitive conditions and leave significant effects on making administrative decisions and directly impact the return of trade strategy performance.
As it was mentioned before, there is no external control and supervision on the performance of traders in this market. Each person implements the rules that they themselves have made and this situation exposes traders to a lot of potential risk. In order to decrease this risk, we need to create a conscious and logical framework, keep it into consideration all the time, and even try to make improvements to this framework as we proceed. If, for whatever reason, we move against the rules of this framework and divert from a path that we accepted as our strategy and tried to maintain during our transactions, we will increase our risks and might endure loses accordingly.
Greed is an unending story and always forces us to want more. The traders who lack realistic goals are always among the main losers of this market. When you enter this market with certain and identified goals and when you achieve the profit you were looking for, the emergence of the feeling that “I could achieve more than this profit” in fact constitutes that the sense of greed is overcoming you.
Then, you will risk your gained profits hoping to get a larger one. This is not only a step toward losing your current profit, but also losing your entire asset.
Gaining profits as the result of a number of profit-making transactions gives traders the feeling that they are capable of doing their transactions perfectly and they do not need any help.
Sometimes certain losses are endured, but the traders tend not to accept their mistakes because of their sense of pride. This pride always acts as an obstacle for achieving success in this market.
“Fear” of failure or loss is among the preventive factors in this market and becomes a hurdle for achieving success and getting profits. This feeling usually appears after a number of unsuccessful transactions and prevents you from carrying other transactions, thus reducing the likelihood of success.
Looking at this market and unsuccessful transactions with a sense of grudge, it creates a feeling in the majority of traders to make up for their losses. This leads to making irrational and uncommon decisions, thus becoming a huge obstacle in the way of successfully exploring in this market.
The term addiction is applied to a habit that is not in one’s nature, but a person enjoys doing it after repeating it for a while and thus gets used to it. As a result, this behavior conquers the individual and controls them.
Repeating transactions without having any pre-plans and only based on a habit could be a common issue in this market. In other words, the trader uses superficial logics that are based on dreams to make transactions. The result of these types of transactions is usually some loss. Due to its non-stop nature and since it is active 24/7, Forex always challenges the traders who have limited capability and assets. The consequence is that traders, because of their sense of not requiring any learning or information, experience failure.
The thought that one could increase their money a few times higher over night or to gain profits consistently and without enduring losses create a false sense of confidence and a wrong belief in traders. Therefore, they are encouraged to enter the market with maximum risk so to achieve the dream success. As it was mentioned before, this is only a dream and nothing else, and will eventually lead to enduring loss.
Do you still trust stop loss as an instrument to control your risk? Based on some studies and psychological factors of the market and also due to the fact that decreasing traders’ loss in this major market is the main goal of this company, Forex always encourages its clients to use a low leverage ratio.
In line with the company’s goals and objectives and based on the fact that clients lose their decision-making power in certain psychological conditions -which were mentioned before, we have the honor to announce that our company is introducing a product called “profit account” by which clients could overcome their inner feelings in a totally lawful environment and have successful transactions.