When it comes to forex investments, some people may opt for time deposits, while others may trade a foreign currency on margin, i.e. leveraged forex trading.
Investors have different objectives when trading forex on margin, e.g. to leverage the investment amount, make a short-term speculative investment, short a certain foreign currency, or simply think fixed deposits in foreign currencies are too conservative. In any case, do bear in mind that margin trading can multiply your investment profits or losses, and leveraged forex is no exception.
To open a leveraged forex contract, you only need to deposit an initial margin that is of a certain percentage (as low as 5%) of the contract amount. Assuming that the value of a Euro contract is 10,000 Euros and the minimum initial margin is 5%, then you would only need to pay a deposit of about HK$4,200 (assuming an exchange rate of one Euro to US$1.08, and US$1 to HK$7.8) to open a Euro margin contract. This is affordable even for investors who are not so well-funded.
With the leverage effect of margin trading, the investment amount, and subsequently the profits or losses, will be multiplied. The lower the margin, the greater the leverage effect. Some investors may feel that the price movements of major currencies such as Euro, Australian Dollar, Swiss Franc and Japanese Yen are not significant on a daily basis, and become unaware of the potential risks of leveraged forex trading. Assuming that the price of foreign currencies rises and falls by 1%, the following table shows the impact of leverage on investment profits or losses.
| Initial margin (%) | Leverage effect (times) | Profit or loss (%) |
|---|---|---|
| 20 | 5 | 5 |
| 10 | 10 | 10 |
| 8 | 12.5 | 12.5 |
| 7 | 14.3 | 14.3 |
| 6 | 16.7 | 16.7 |
| 5 | 20 | 20 |
As you can see, leveraged foreign exchange contracts should not be taken lightly. Sometimes economic events such as monetary policy changes including interest rate rises or cuts, or political events like Brexit, can fluctuate currency prices significantly within a short period of time. If the price movements go against your expectation, leveraged foreign exchange transactions may result in substantial losses. According to a recent survey on leveraged foreign exchange trading published by the SFC, in 2018, 61% of the investors engaged in leveraged foreign exchange trading suffered losses, and 1% lost more than HK$1 million.
As in the case of margin trading in other financial products, investors carrying out leveraged foreign exchange trading face the risk of margin call by brokerages within a short period of time; if at the end the investor is forced to close his/her position, he/she will suffer a loss well beyond the margin deposit. As such, margin trading is not suitable for investors of low risk tolerance or long-term holding perspective.
