with regards to trading platforms what is meant by losses can exceed deposits.I know I can make losses bigger then what I put down for trades but does this also mean losses bigger then my account size if so could I potentially get into debt with a trading platform?
If you trade stocks and fully pay them - no leverage - then your losses cannot exceed your account size.
The same applies to long option positions. The worst that can happen is that they expire worthless.
However, if you trade on margin - this includes FOREX or futures - you do not need to pay the full amount of the principal. Examples are easier to understand then theoretical explanations, therefore let us look at two specific cases.
You go long one contract for the FDAX via a futures broker. Your futures broker will require that you have enough money in your account to comply with the margin requirements. To open a position intraday - not holding it past the market close - the day trading margin requirements are
Basically this means that you can open that 1 lot position of FDAX with an account size of $ 3,000 (Amp or NinjaTrader), but would need an account size of about $ 15,000 to do that with Interactive Brokers.
Now let us assume that you hold a long position of FDAX, and all of a sudden there is an adverse move of 3% against your position. What would that mean?
A 1 lot position of FDAX is currently worth 11400 points or € 285,000. Converted to USD this would be $ 320,000. Therefore a drop of 3% would result in a loss of $ 9,600. The result of that 3% drop in FDAX would be
Of course the broker would try to close out your position to avoid that more than your initial margin is burned. But this does not always work.
The problem of high leverage
The problem here is high leverage. Let us have a look at the recent announcement of the Swiss National Bank to give up support for the EURO. In fact the Swiss National Bank is partly owned by private investors, so they are not allowed to engage in loss producing currency games and to stop their support, before the losses incurred threatened their financial stability. The sudden notice led to a 15% move in the Swiss franc, meaning
-> that about half the traders of a FOREX broker made a significant gain of 15% of the principal
-> while about half the traders of a FOREX broker made a significant loss of 15% of the principal
Many of the international brokers offered a leverage of 1:100, meaning that they allowed retail traders to trade on a deposit of 1% of the total value of the currency position. The 1% deposit was not enough to cover the 15% loss of the losing traders with the following result
-> all the high leveraged retail traders that had a short position in the Swiss franc blew up
-> the FOREX brokers had to cover the losses from their losing customers, but pay the gains to the winning customers
Some of the FOREX brokers allowing for high leverage were not able to meet their requirements and went bust. Now you know why FXCM and Alpari UK did not survive that move of the Swiss Franc.
High leverage threatens both retail investors and brokers. A sudden move endangers both funds of the retail trader and the financial stability of the broker.
Personally, I would not allocate significant funds to any high leverage broker. The so called 6-sigma events (based on a normal distribution) are quite frequent and there is one every few years. A single such event is good for blowing up your account and closing down low margin brokers.
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With futures (and currency trading), you can very easily lose more than you have in your account. Generally your broker will close you out first, but it can happen almost effortlessly if they do not.
Reason: you only have to have a relatively small amount of money in your account -- called your margin -- in order to trade. Margin is simply an amount that is expected to be large enough to cover any losses for the particular instrument you are trading. (Set by the exchange -- for futures -- for overnight trading, by the broker for day trading.)
Because the price of a futures contract or a currency position can easily move more than the amount you have in your account, you can be not only wiped out, but still owe more, if the broker didn't close you out in time. And yes, they will pursue you for it.
Welcome to futures and currencies. It is a good idea to understand all this before you attempt to trade them, to avoid very unpleasant surprises....
It's a matter of leverage cutting both ways. Be careful out there.
Edit: I see that @Fat Tails put up a better explanation while I was typing this.... Same point, though. Be careful of the leverage.
Last edited by bobwest; March 2nd, 2015 at 07:48 AM.
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It happened on a massive scale only a few days ago, bankrupting countless brokers, when the Swiss Franc moved rapidly.
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Well, for instance, today the ES (S&P stock index futures) moved about 12 points, which is not much for it.
The value of 1 point on ES is $50. So the dollar value of the move was about $600, per contract.
There are brokers that will allow a trader to have as little as $500 in margin per contract. You can see the problem, if a trader had that small an amount, and was short and tried to stay short all day -- with one contract, that's a $600 loss, and if he only had $500 in margin in his account, well.... he would have either been closed out by the broker in time, or would have been in trouble by about $100. Per contract. And this was a relatively quiet day.
But since people who like over-leverage like to trade many contracts, it could have been much, much worse.
The broker would, of course, try to cut his loss (because if he can't get it from you, he eats it) by closing you out in time, and today, on ES, that would have been easy. But sometimes price will jump very quickly, and it may be hard or impossible to liquidate in time. Then you will owe the money, and you will be pursued for it.
@Fat Tails mentioned, in his post, the recent case with the Swiss Franc, when Swiss National Bank suddenly changed its policy of maintaining the value of the Franc, and price moved enormously and suddenly. Not only were customers wiped out, but so were entire firms.
So, yeah, this is not some never-heard-of, rare type of thing. (The Swiss situation is, but the general situation is not.)
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