Change is coming to America.
No, this isn’t a new Obama speech. It’s what is happening to the forex market as far as U.S. clients are concerned.
The regulators in the U.S. just made a new ruling concerning forex trading in the U.S.
You see, the leverage in the forex market has been 100 to 1 or more in the past. Initially these regulators (the Commodity Futures Trading Commission, or CFTC, and the National Futures Association, or NFA) wanted to take the amount of leverage that could be used down to 10 to 1.
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This caused a huge uproar in the industry. The brokers complained to the CFTC. In fact, in its history, these regulators got more letters about this issue than they’ve ever gotten about any issue to date.
Along with the brokers, the clients of these brokers personally wrote their regulators as well. They were outraged, to say the least.
Since there was such an outrage to the regulators, they reached a compromise. Instead of taking the leverage down from 100 to 1 down to 10 to 1, they decided this is what they’d do: They would take the leverage on the major currencies down to 50 to 1 and they’d take the leverage down on the exotic currencies down to 20 to 1 (from their present level of 25 to 1).
Personally, I think these regulators were “testing the waters” to see what they could get by with without a total revolt on their hands.
I also think that they were using a strategy that worked.
In fact, here’s how it goes. Many years ago, there was a study conducted.
The study wanted to test a theory. The theory is this: Find out what you want. Then ask for far more than that. Your initial request will likely get rejected. Once it does, ask for much less and you’ll likely get it.
So here’s how the study went.
They commissioned two groups of people. Both of the groups were instructed to go out and see how many people would give them $5 just simply by asking for it. However, there was one distinct difference.
The first group was simply instructed to go out and ask people for $5. If they got it, great. If not, oh well. They weren’t to ask anything else of the person.
The second group had a goal of getting $5 from people in the crowds but they were instructed to ask for $10. Then once the $10 request was denied (most of the time), they’d go back and ask, “OK, well would you at least give me $5?”
What they found is that the second group came back with far more money because of the psychological difference between the two requests.
You see, the second group had an edge because the “psychological bar” was set so high on the first request for $10, that when they then backed off and asked for half that much, it seemed much more reasonable and they were far more likely to actually get the $5 they wanted in the end anyway.
This is what I think the U.S. regulators did (and they did it very well, I might add). They wanted to take the leverage down tenfold. Then once the psychological threshold caused an outrage, they asked for the leverage to be cut in half instead … and they got it.
So starting Oct. 18, this new “lower leverage” will go into effect in the forex market for U.S. clients.
Now this can be a good thing and a bad thing in my opinion.
It could be bad because the competitors of these U.S. firms don’t have to lower their leverage. Only the U.S. regulated firms have to do this.
However, it could be a good thing because many retail forex traders overleverage their accounts anyway. That’s why they don’t last. So this is really a much more reasonable amount to be used anyway.
In my forex trading service called the Money Matrix Insider, we end up using more like 10 to 1 or 20 to 1 type of leverage when we trade. This is what pros use and it’s why they last and the average retail account does not last.
So I’ve been keeping my MMI members using “sane” leverage the entire time no matter what was required. But the industry as a whole didn’t do this.
One more thing I think that could be good about the new leverage rules is that it could cause more people to come into the market that would have never considered it when it had 100 to 1 or 400 to 1 leverage. They just felt that was insane and so (in their eyes), the investment lost much of its legitimacy for them. After all, this is a far cry from the stock market’s 2 to 1 leverage.
Now I must clarify one point. Stocks can move many cents or even several dollars a day in their price fluctuations. Currencies on the other hand, tend to move a fraction of a penny per day. So this is why they need to be levered in order to make them tradable instruments.
So when the movement in something is so small, it has to be magnified with leverage many times over in order to make the potential moves worthwhile. This is why the currency market carries so much more leverage than the stock market does.
The currency market also has greater volume, tighter spreads and fewer gaps in its trading too which also makes it more conducive to levered trading.
Iin the end, these new rules may be a good thing for the retail trader (unless they persist in continuing to take down the leverage lower and lower from this point).
For now, it’s a good thing for the retail trader.
About the Author: Sean Hyman
Sean Hyman is a member of the Moneynews Financial Brain Trust. Click Here
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