Leverage, gaps, the broker itself, and a tax treatment that depends on the product

The biggest forex risks are leverage and sudden gaps. Costs include spreads and overnight financing, and tax treatment varies widely by product and country.

11 min read · Level 5

The point

Costs in forex are small in each trade and decisive across many, and that combination is exactly the kind of thing people reliably underestimate. I would evaluate any currency strategy by first asking how many pips per trade it needs just to stay level, and then asking honestly whether the trader has any reason to expect to beat that consistently against professionals who pay far less to trade.

What is it?

The risks:

Risk What it looks like Leverage small moves remove large parts of the margin Gaps and slippage prices jump past stops around news or weekends Broker counterparty the firm on the other side may be poorly regulated or fail Negative balances losses beyond your deposit where protection does not apply Behavioural frequent trading, chasing losses, trading around the clock

The costs, for one standard lot held for 20 trading days:

Spread (2 pips) 20 dollars Commission (if charged, e.g. 7 per lot) 7 dollars Rollover at, say, -1.50 per day 30 dollars Total 57 dollars

That is 5.7 pips of movement needed just to cover costs, before any profit.

Taxes differ sharply. Depending on the country, currency trading gains may be taxed as capital gains, as ordinary income, or under special rules for certain futures contracts; some products, such as spread bets in some jurisdictions, receive different treatment from CFDs or spot trades; and frequent trading can change how tax authorities classify the activity. Losses may or may not be usable against other income.

Why does an investor care?

Because costs matter enormously in a market where the underlying moves are small. A short-term strategy that makes a few pips per trade can be profitable before costs and unprofitable after them.

The broker risk is also specific to retail forex. When you trade a CFD or spot product with a broker that is also your counterparty, its solvency and conduct are part of every trade.

And taxes can reverse a decision: a strategy that looks acceptable pre-tax may not be after tax, depending on product and jurisdiction.

This is educational information, not tax or accounting advice. Rules differ by country and change — get advice from a qualified professional in your jurisdiction before acting.

Educational, not personalised financial advice. Nothing in the Investor Academy is a recommendation to buy, sell or hold anything — what is right for you depends on your own circumstances and the rules where you live.

Sources: U.S. IRS - official tax information; UK Government - Capital Gains Tax guidance; OECD - tax policy and statistics; UK FCA - information for consumers

Example

A trader's month. Twenty trades of one standard lot each, gaining an average of 4 pips before costs.

Gross gain: 20 x 4 pips x 10 dollars 800 dollars Spreads: 20 x 20 dollars 400 dollars Commissions: 20 x 7 dollars 140 dollars Net before tax 260 dollars

If the average gross gain had been 2 pips instead of 4, the gross gain would be 400 dollars and costs of 540 would leave a loss of 140. A two-pip difference in edge turned a profit into a loss.

The common mistake

Evaluating a trading strategy before costs. In forex, spreads, commissions and financing often decide whether a strategy makes money at all.

How it works

Step 1: Compute costs in pips per trade

Add spread, commission and expected rollover, and convert to pips so you can compare them directly with your expected gain.

Step 2: Confirm negative balance protection

Find whether your account can go below zero after a gap.

Step 3: Check regulation and client money rules

Confirm the broker's authorisation and how client funds are held.

Step 4: Get tax advice on the specific product

Ask how gains and losses on your product are taxed in your country and whether frequent trading changes that.

When to use this

Before opening a forex account and when reviewing whether a trading approach is profitable.

When not to use it

Do not rely on general tax descriptions for your own filings; rules vary by product, country and circumstances.

How investors actually did it

A recurring pattern: broker insolvency after extreme volatility

Following the Swiss franc move in January 2015, several foreign exchange brokers in different countries reported losses that exceeded their capital because clients' negative balances could not be recovered. At least one broker entered insolvency, as reported at the time, putting client funds at risk.

Your broker's financial strength and the client money rules that protect you matter most in exactly the events that also hit your trades.

Do this now

Convert your broker's typical costs into pips per trade
Check whether your account has negative balance protection

Create a free account to read the rest and apply it to your own investing.

Related lessons

Leverage: the same asset, a different outcome — Borrowing to invest does not change what you own. It changes how far the asset can fall before the decision is taken out of your hands. (11 min)
Appraising one trade: size it from the loss, not from the leverage — Before a currency trade, set how much of your account you will risk, where the trade is wrong, and what the broker and costs add. Position size follows from those, never from the maximum leverage available. (12 min)
Why two identical returns are taxed differently — Most tax systems care less about how much you made than about what kind of money it was and when you took it. Same return, different asset, different amount kept. (13 min)