Even new traders know that leverage is an important part of retail FX trading. In fact, it is what attracts so many traders to this industry. However, some Forex brokers that you will encounter in your trading career offer floating leverage.
What is floating leverage?
But what does floating leverage actually mean? Is it bad or good for your trading? Those questions trouble many aspiring Forex traders.
There are two types of floating leverage:
Volume-based floating leverage
Volume-based floating leverage is a kind of leverage that changes (usually, decreases) as the volume of the open positions grows.
Example
You are normally trading with the 1:500 leverage. Once the total volume of all your currently open positions exceeds $3 million, the leverage goes down to 1:400, but only for the volume above $3 million, so that you do not have to worry about increased margin requirement for the rest of your positions. When the volume exceeds $5 million, the leverage goes down to 1:200 on everything above the threshold volume. After $7.5 million, it declines to 1:100 and so on.
As demonstrated in the example, the general dependence is always the same: you will need more margin to hold positions at higher volumes.
Brokers that offer volume-based floating leverage include such popular ones as InstaForex and Alpari.
Equity-based floating leverage
Equity-based floating leverage decreases or increases based on your account's equity (balance + floating profit). It doesn't matter how many and how big trades you currently have in the market; it depends solely on your equity.
Example
Your normal leverage is 1:500. Once your equity exceeds $10,000, your leverage goes down to 1:400. Usually, this will affect only your new trades, leaving margin requirements for your current trades unchanged. Then, for example, your equity rises to $20,000, the leverage goes down to 1:200. Then, after, say, $50,000 equity hurdle is passed, your leverage declines further to 1:100 and so on.
As you can see, with equity-based floating leverage, the higher your equity becomes (the bigger your account is), the lower leverage you get from your broker.
Among notable retail brokers employing this model are RoboForex and Exness.
Why brokers use floating leverage?
So, why do brokers do it? First, FX companies reduce their own risk by providing less leverage on
Is floating leverage dangerous?
So, can it be dangerous? Yes, in some cases floating leverage can be. Particularly, when trading using a volume-based floating leverage the following situation may arise.
While floating leverage will not change your margin requirement for the volume, which is below the threshold value, the sudden change in currency rates may push your open volume above the threshold, increasing the margin requirement for a part of it.
Example
Your broker uses the following simple leverage scheme: 1:500 for volume below $1 million and 1:250 for volume exceeding $1 million. You have a GBP/USD position open for 6.5 standard lots (650,000 GBP). At the GBP/USD rate of 1.5000 the total USD value of this position is $975,000, and the required margin to hold that position would be $1,950. If the GBP/USD rate rises to 1.6000, with fixed leverage the margin requirement would rise by as little as $130 to $2,080. But the total USD value of this position rises with GBP/USD — from $975,000 to 0 $1,040,000, which is above the $1 million threshold. So, the floating leverage results in the increase of the required margin to $2,000 (for volume below $1 million) + $160 (for volume above $1 million). As you can see, the actual value is $80 higher than if it would be with the fixed leverage. Now, you could say that $80 is not too much compared to $2,080 margin (~4% difference), but you should be aware of this potential jump in your margin requirement when you plan your trading strategy.
For equity-based floating leverage, the risk exists only if your broker adjusts margin requirements to trades that had been opened before your equity moved to a new tier.
You should always study your broker's conditions for floating leverage carefully to avoid unpleasant surprises with unexpectedly high margin requirements.
If you have further questions on floating leverage or if you would like to share your commentary on this topic, feel free to discuss it on our Forex forum.
