• There is a difference between broker types and their regulation levels.
  • Conflicts of interest may arise in one-sided markets. 
  • Leverage is used all the time, and the key is not to use it excessively. 
  • It is the trader's responsibility to either avoid risky brokers and high leverage. 

Why do market-makers provide high leverage? Given that a high percentage of forex traders lose money, do these brokers take advantage of traders' risk? Or do brokers pass the orders to the interbank network and make money off of spreads? Here are a few answers.

* This post originally appeared as a response to a Premium user's question in Trading Studio. Sign up to get access to FXStreet's top analysts. 

Types of brokers

There are different types of brokers, and the short advice is to use regulated brokers. There is a lower chance of the broker working against the trader – and at least someone to complain to in such a case. 

The longer answer – albeit not a full description of all brokers – is that some transfer orders to the interbank network and some do not. Those that pass all orders to the network are intermediaries, making money off of spreads and sometimes fees they charge from users. 

Market makers may match orders from different traders. For example, if there is one user going short on EUR/USD and another going long, using the same size, these orders balance each other. In this case, there is no need to pass the order to the interbank market.

When the balance breaks

The problem arises when the balance significantly breaks, and everybody goes in one direction and the broker does not pass the orders to the interbank network. In that case, the broker is basically positioned against its clients, which is a problematic conflict of interest. 

In the infamous case of the "SNBomb" from January 2015, brokers relied on the Swiss National Bank's promise to maintain the 1.20 floor under 1.20. When the SNB suddenly let go of the peg, EUR/CHF collapsed. That caused some brokers to go bankrupt. 

Conflicts of interest

But even in normal conditions, that conflict of interest mentioned earlier is problematic enough. First, if all the traders make the right bet and the broker doesn't cover, there is a risk for the broker and risk for traders – being unable to withdraw funds

Secondly, it means that these brokers assume that most traders will not only lose money but also fully liquidate their accounts. In such cases, the brokers' income comes not from spreads but from the traders' deposits – almost everybody would liquidate their accounts. 

Leverage, the good, the bad and the ugly

Regarding leverage, it is a tool used by all types of traders, investors, and banks to make money. There is nothing inherently wrong with leverage, as that is what allows markets to function at a faster rate. Even at the strictest jurisdiction, the most prudent banks use leverage when holding only a small amount of deposits as a guarantee against bigger loans.

When people take out mortgages, they leverage a small downpayment in order to buy a house, and most of them pay their debts.

The problem begins when leverage becomes excessive, turning a small trade into a big gamble. Leverage levels of triple digits are undoubtedly excessive, and some brokers take advantage of the temptation to use only $1,000 to make a trade worth $100,000. That can have devastating consequences as the opportunity to make significant gains also means a high probability of demolishing the account.

When the account vanishes quickly, not only the money is gone, but also the lesson.

The trader's responsibility is not to use excessive leverage, even if it is offered by the broker. More reasonable levels should be used, resulting in smaller profits – but a higher chance of learning from losing trades before liquidating the account. 

Final thoughts

Some brokers try to temp traders to use high leverage. It is the trader's responsibility to use lower leverage or to switch to another broker, if they think their practices are risky. Circling back to the beginning, the best practices are: trading with a regulated broker, and using low leverage, especially in times of high liquidity. 

Information on these pages contains forward-looking statements that involve risks and uncertainties. Markets and instruments profiled on this page are for informational purposes only and should not in any way come across as a recommendation to buy or sell in these assets. You should do your own thorough research before making any investment decisions. FXStreet does not in any way guarantee that this information is free from mistakes, errors, or material misstatements. It also does not guarantee that this information is of a timely nature. Investing in Open Markets involves a great deal of risk, including the loss of all or a portion of your investment, as well as emotional distress. All risks, losses and costs associated with investing, including total loss of principal, are your responsibility. The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of FXStreet nor its advertisers. The author will not be held responsible for information that is found at the end of links posted on this page.

If not otherwise explicitly mentioned in the body of the article, at the time of writing, the author has no position in any stock mentioned in this article and no business relationship with any company mentioned. The author has not received compensation for writing this article, other than from FXStreet.

FXStreet and the author do not provide personalized recommendations. The author makes no representations as to the accuracy, completeness, or suitability of this information. FXStreet and the author will not be liable for any errors, omissions or any losses, injuries or damages arising from this information and its display or use. Errors and omissions excepted.

The author and FXStreet are not registered investment advisors and nothing in this article is intended to be investment advice.

Education feed Join Telegram

Editors’ Picks

EUR/USD stays below 1.0400 on soft EU inflation data

EUR/USD stays below 1.0400 on soft EU inflation data

EUR/USD clings to modest daily gains above 1.0350 during the European trading hours. Eurostat reported that annual Core HICP remained steady at 5% in the Eurozone in November as expected. Investors await key data releases from the US and Powell's speech.

EUR/USD News

GBP/USD recovers from 1.1940 as US Dollar refreshes day’s low, Fed Powell’s speech eyed

GBP/USD recovers from 1.1940 as US Dollar refreshes day’s low, Fed Powell’s speech eyed

GBP/USD has sensed responsive buying action around 1.1940 as risk aversion loses luster. The Bank of England is expected to advance its interest rates to 4.25% in Q1CY2023. GBP/USD has gained strength after testing the 200-EMA around 1.1960.

GBPUSD News

USD/JPY holds steady above mid-138.00s, upside remains capped amid softer USD

USD/JPY holds steady above mid-138.00s, upside remains capped amid softer USD

USD/JPY lacks any firm direction and seesaws between tepid gains/minor losses on Wednesday. Sluggish US bond yields keep the USD bulls on the defensive and act as a headwind for the pair. The Fed-BoJ policy divergence continues to lend support ahead of US data and Powell’s speech.

USDJPY News

Editors’ Picks

EUR/USD stays below 1.0400 on soft EU inflation data

EUR/USD stays below 1.0400 on soft EU inflation data

EUR/USD clings to modest daily gains above 1.0350 during the European trading hours. Eurostat reported that annual Core HICP remained steady at 5% in the Eurozone in November as expected. Investors await key data releases from the US and Powell's speech.

EUR/USD News

GBP/USD recovers from 1.1940 as US Dollar refreshes day’s low, Fed Powell’s speech eyed

GBP/USD recovers from 1.1940 as US Dollar refreshes day’s low, Fed Powell’s speech eyed

GBP/USD has sensed responsive buying action around 1.1940 as risk aversion loses luster. The Bank of England is expected to advance its interest rates to 4.25% in Q1CY2023. GBP/USD has gained strength after testing the 200-EMA around 1.1960.

GBPUSD News

Gold bulls seek validation from $1,760 and Fed Chair Powell

Gold bulls seek validation from $1,760 and Fed Chair Powell

Gold price remains firmer for the second consecutive day, bounces off 10-DMA, short-term key support. Fed Powell’s first speech after November, hawkish hopes tease Gold sellers.

Gold News

Three on-chain metrics suggest Bitcoin price has bottomed, here’s where BTC is going next

Three on-chain metrics suggest Bitcoin price has bottomed, here’s where BTC is going next

Bitcoin price action has spiked 5% over the last 24 hours, hinting at the start of an optimistic scenario. Previous publications have already explored why BTC is ready for a bear market rally from both short-term and long-term outlooks.

Read more

ADP Jobs Preview: Markets set to find more reasons to sell the Dollar, big beat needed to boost it Premium

ADP Jobs Preview: Markets set to find more reasons to sell the Dollar, big beat needed to boost it

ADP's jobs report has finally come in line with the official NFP report. It took a hiatus and a change in formula to make that happen, but what matters is that this release finally matters. 

Read more

RECOMMENDED LESSONS

7 Ways to Avoid Forex Scams

The forex industry is recently seeing more and more scams. Here are 7 ways to avoid losing your money in such scams: Forex scams are becoming frequent. Michael Greenberg reports on luxurious expenses, including a submarine bought from the money taken from forex traders. Here’s another report of a forex fraud. So, how can we avoid falling in such forex scams?

What Are the 10 Fatal Mistakes Traders Make

Trading is exciting. Trading is hard. Trading is extremely hard. Some say that it takes more than 10,000 hours to master. Others believe that trading is the way to quick riches. They might be both wrong. What is important to know that no matter how experienced you are, mistakes will be part of the trading process.

Strategy

Money Management

Psychology