Leverage by Malcolm Morley

Leverage by Malcolm Morley

It is a popular misconception that the market maker with whom we deal lends us money when we use leverage. This isn’t correct. The following thread discusses what really happens, but also goes off to discuss a number of the finer points of trading fx (threads are like that!). For those interested in how things really work, it is a good read.

It is a popular misconception that the market maker with whom we deal lends us money when we use leverage. This isn’t correct. The following thread discusses what really happens, but also goes off to discuss a number of the finer points of trading fx (threads are like that!). For those interested in how things really work, it is a good read.

Extract:

You are right when talking about physical delivery. We would have to borrow one side of the transaction, and deposit the other. However the fx market only physically delivers a fraction on the volume traded and we, of course, NEVER get to physical settlement. All we are doing is going through the motions, and settling the net difference in p/l.

Even in the broader interbank market where there is ultimately physical settlement, players with positions rollover these positions daily to avoid the capital expense of holding their long or short view. The only physical deliveries that need funding tend to be for commercial requirements only, not for speculation. All the rest are netted out. We, by contrast, have continuous interest payments that factor in rollover costs. (btw rollover costs are calculated from interest rate differentials).

Basically, as long as the physical delivery of an outright position is always deferred, by whatever means, no real loan needs to take place. It’s all virtual, and can be settled net.

I have lived and breathed trading ever since trading fx professionally in London, Toronto and Philadelphia in the early 70's (yes I know that shows my age!). While my professional career subsequently took me from the trading desk to designing treasury systems for some of the world's leading financial institutions, my desire was to always trade for myself. As a consequence, following 5 years with a major international stock-broker (the last 3 as... More