-You open one lot (100,000), buying with the British pound at 1% margin and wait for the exchange rate to climb. When you buy one lot (100,000) of GBP/USD at a price of 1.5000, you are buying 100,000 pounds, which is worth US$150,000 (100,000 units of GBP * 1.50 (exchange rate with USD)). If the margin requirement was 1%, then US$1500 would be set aside in your account to open up the trade (US$150,000 * 1%). You now control 100,000 pounds with US$1500. Your predictions come true and you decide to sell.
-You close the position at 1.5050. You earn 50 pips or about $500. (A pip is the smallest price movement available in a currency).
Say I make that trade and profit $500 dollars, how does this translate into what I actually have? Because it seems very unlikely that I would make $500 on my initial $1,500 investment.
The short answer to your question is, "Yes, you made $500 profit with your $1,500 account. After your trade is closed, your account balance will be $2,000.
A 50-pip profit at $10 per pip (which is assumed in your example) produces a $500 profit, regardless of the size of your account, and regardless of leverage or margin.
But, the trade you described is insane, because you used the maximum leverage allowed by your broker.
Technically, your broker would close that trade the instant it was opened. Here’s why.
As soon as you enter that trade, your entire account balance would be set aside as margin. Then the spread would be deducted from your balance, making your balance negative — at which point your trade would be closed automatically, and your platform would start flashing “Margin Call”.
If your broker’s spread was, say, 4 pips on the GBP/USD, the spread would have cost you $40, and your account would then have a balance of $1,460.
Some brokers, including mine (FXCM), treat 100,000 units of base currency the SAME for all pairs. In other words, one standard lot of GBP/USD (100,000 units of currency) is treated as $100,000 worth of currency.
If you placed your hypothetical trade with FXCM, the margin required on 1 standard lot (of GBP/USD, or any other pair) would be $1,000 (1% of $100,000). In this case, you would have enough in your account to cover the margin, the spread, and a small loss — before your account balance reached zero, and you received a margin call.
But, that doesn’t make your hypothetical trade any less insane. I hope you know why such a trade would be insane.
nano-lot=100 units=$0.01/pip (a penny a pip) 100:1 means $1.00 margin minimum
micro-lot=1000 units=$0.10/pip (a dime a pip) 100:1 means $10.00 margin minimum
mini-lot=10,000 units=$1.00/pip (a dollar a pip) 100:1 means $100.00 margin minimum
standard-lot=100,000 units=$10/pip (ten bucks a pip) 100:1 means $1000.00 margin minimum
Remember what Clint said–the spread is deducted from your account [B]THE [/B][B]VERY INSTANT [/B]the trade is opened. If that puts you under the margin minimum, your open trade will be closed just as instantly. You will still be out your spread money.
Proper position size is a function of risk. “Proper”, in this context, means reasonable, sensible or prudent.
Most experienced traders will tell you that you should risk no more than x% of your account on any one trade. Defining “x” is a subjective matter. But, most recommendations fall within the 1%-5% range. The most commonly cited value for “x” is 2%.
Let’s use that figure.
Determining risk may be a simple matter, or not.
An example of a simple case is this: You place a stop-loss order 40 pips away from your entry price, and you honor your stop-loss (that is, you don’t move it around, when you see the price heading toward it). In this case, your risk is clearly defined as
(40 pips/lot) x (the $-value of 1 pip) x (the number of lots in this trade).
Here’s an example in which determining risk is not so simple. Your trading method involves actively managing your trades. You enter on market orders, based on price action; and you exit manually (with or without a profit) based on price action. You place a catastrophic stop-loss order 100 pips away from your entry price, just in case your computer blows up. You have no intention of ever letting a loss get as big as 100 pips. But, you can’t say definitively how large any one loss might be, because price action dictates when you exit. In this case, you will have to make a reasonable judgment call regarding the average risk associated with this method of trading.
Let’s go back to the simple case, above.
Let’s say that you want to trade the USD/CHF with a 35-pip stop-loss. You have a $1,500 micro account.
For the USD/CHF, the dollar-value of 1 pip is (currently) $0.09/pip/micro lot.
Therefore, your risk on this trade is (35 pips) x ($0.09) x (number of micro lots), and you want to limit this risk to 2% of your account balance.
So, (35 pips) x ($0.09) x (number of micro lots) = (0.02) x ($1,500)
When you solve that equation, you get: Number of micro lots = 9.52, which you would round down to 9 micro lots.
If that trade is stopped out, your loss (including the spread) will be a little bit less than 2% of your account balance.
The general form of the equation, above, is:
[B]Position size, in mini lots = (Account balance, in dollars) x (Risk %) / (Stop-loss, in pips) x (Pip value, in dollars)[/B]
Hope that answers your question.
By the way, in your first post you said the following:
I think you understand this, but let me say it anyway.
Leverage doesn’t add money to your account. Your account balance (in the example) is $1,500.
The broker’s maximum allowable leverage allows you to trade UP TO $150,000 worth of currency with your $1,500 account.
I had a big problem understanding leverage, margin and lots.
Im still not 100% sure about everything, but those posts by [B]Clint [/B]and [B]potaire [/B]made many things more clear to me!
Amount of risk can be very simple to figure out. First, decide what percent of your total money you wish to risk on just one trade. Say you have $1500.00, and you are comfortable risking 10% on one trade (kinda high, but makes for easy math). Well, simply put, you can lose no more than $150.00 on your next trade. Then you must decide on how many pips you are willing to lose before you pull the plug on the trade. Let’s say you decide on 30. So, just do Clint’s math (or figure it out in your head on an easy one like this) and see that if you lose 30 pips, but can not lose more than $150.00, than each pip can be worth no more than $5.00 a pip. That would be a half of a standard-lot, or 5 mini-lots, or 50 micro-lots, etc, etc. They all equal 50,000 units, so they are all the same thing.
So, with an account of $1500, using a risk of 10% and a stop-loss of 30 pips, a trade of 50,000 units would be your max. In this case, you are only using a 33.3:1 rate of leverage (controlling 50,000 units with $1500).
Interesting thread I have really struggled with leverage and position size, please bear with me on this, I’m trying to work out the difference/ benefits of Mini v Standard and 100:1 v 10:1 leverage
For example $10,000 account risk 3% and stop loss 40 pips, using your equations I worked out the lot sizes for Mini and Standard
This makes sense (hope it’s correct) but now what I’m trying to get my head around is the difference between 10:1 and 100:1 leverage, when I open demo accounts I have initial option to select leverage
With the $10,000 account is this correct margin for the above example?
Mini account 7.5 lots with
10:1 leverage = $7,500 margin?
100:1 leverage = $750 margin?
Standard account 0.75 lots with
10:1 leverage = $7,500 margin
100:1 leverage = $750 margin
All four examples are the same profit/ loss? I guess I’m still missing something because it seems to me better to take 100:1 leverage as margin is so high for 10:1, but the general advice seems to be take lower leverage, what have I missed here? Why go mini/ standard & 10:1/ 100:1
PipSmash, the bottom line is this: Your $ gains and/or losses are determined by your position size and only by your position size. Leverage only speaks to how big the position is relative to your account size, and margin is just how much of the position value you must post.
So, your P&L is going to be the same whether you trade 1 full lot, 10 minis, or 100 micros. Similarly, your P&L will be the same regardless of whether you’re trading at 1:1 or 1000:1 leverage if the position size is the same.
In a bid to sensitize people on the dangers inherent in high leverage, I’ve often heard people say stuff like, “your broker may offer you leverage of 400:1, that doesn’t mean you should USE IT, the choice is up to you…”.
Do they not mean to say, “…that doesn’t mean you should CAPITALIZE ON IT… and start buying more and more lots (which could lead to a disaster should the market go against you)”?
I’m asking this because from my understanding, on opening (most) forex accounts, you inform your broker the leverage you would like to use from those he makes available, (say, you choose 100:1, for example)- and that leverage is what every trade of yours will be based on.
Given a $250 bank acc, and a trading strategy like SL = 70p, R = 2%bank, TP = 3R. To find the optimum lot size to trade the strategy.
(i) . Find how change in price on chart will affect account.
For GY = 140.00, 1pip = 0.01, & $/G=1.5630
Then 1pip value = 0.01 over 140 = 0.000714 pound value, times 1.5630 for dollar terms = 0.000111, appx. = 0.0001
For $Cad = 1.0698, 1pip = 0.0001
Then 1pip value = 0.0001 over 1.0698 = 0.0000934 dollar value, = apppx. 0.0001
For G$ = 1.5630, 1pip = 0.0001
Then 1pip value = 0.0001 over 1.5630 = 0.0000639 pound value, times 1.5630 for dollar value = 0.000099, appx. 0.0001
For all other currency pairs, 1pip value will appx. 0.0001 dollar terms.
(ii) . To enter a trade, various choice of lot size
Lot size;
Std. = 1 lot = 100,000 units of base currency of pair
Mini = 0.1 lot = 10,000
Micro = 0.01 lot = 1,000
For 1pip change, effect on account for respective sizes = 1pip value times lot size
Std = $ 10, Mini = $1, Micro = $0.1
For 30p change,
Std = $ 300, Mini = $30, Micro = $3
(iii) . We can then calc dollar gain per pip per lot size; 1p,2,3,4,5p,10p, 25,20,25,30,35,40,45,50p, 60,70,80,90,100p, 200,300,400,500,…1000p; and also each pip change by different position sizes like micro – 0.01,.02,.03,…05, mini – 0.1,.2,.3,…5, mini – 1,2,3,…10. We will then arrange everything on a table, that way we’ll never have to calc it again. Here, I have attached the table in pdf.
(iv) . Now, I calc figures for my position size. 2% of $250 comes to $5. I want that to be my risk ® in the trade. From the table, we can even shade a diagonal boundary of max pip change per lot size in $, and thus max optimum lot size for every intended trade, that fall within R = 2%Bank limit. Not as many as for a bigger account. For SL = 70p, it would limit the options further to only those lot sizes whose 70p move wont exceed $5. For SL = 20p!, not withstanding that it would get triggered more than would allow for any edge whatsoever, we would be able to place heavier lots and still meet R = 3%, thus loose bigger per pip move. This is not a “get rich quick” thing, thus TP is usually equal to 12 – 15% or so of the account in bliss weather. Not 70% in one trade, atleast not twice in rows. And that method for kinda estimating optimum size just wont cut it for long, however anyone does it, but only by knowing it first.
Conclusion; you realize that so far nowhere has leverage been used to determine our actual profit figures, but it only outlines the amount of money you put up to be in any trade position. Lyke now notice these lot sizes are in their thousands, and we are using a $250 acc for the example. To buy any size, there will be your brokers money involved in the ratio of leverage, but only your money can get lost in that once money in your account cant support that ratio, broker closes all positions, with his side of the ratio intact.
I have no idea what your first question means. You’re trying to make a distinction between “using” maximum allowable leverage, and “capitalizing” on maximum allowable leverage?
And your last sentence has me baffled, as well, when you say “…and that leverage is what every trade of yours will be based on.”
After all the discussion about “leverage” on this thread, I wonder whether you understand the [B]two meanings[/B] of the word.
Let’s go through it one more time.
[B]1. The [U]maximum leverage[/U] your broker will allow you to use on any trade.[/B]
Let’s say the broker gives you your choice of maximum allowable leverage (as you alluded to in your post).
And let’s say that you designate 100:1 as your maximum allowable leverage.
Immediately, we know 2 things:
[ul]
[li]whenever you enter a trade, your broker is going to require a margin amount of 1% of your position size
[/li]
[li]at no time, will your broker allow you to have open positions totaling more than 100 times your account balance
[/li][/ul]
[B]2. The [U]actual leverage[/U] you use on a particular trade.[/B]
Let’s say that your broker offers you maximum leverage of 100:1. And let’s say that you have $1,000 in a micro account.
Finally, let’s say that you want to trade micro-lots of USD/JPY.
If you trade 1 micro-lot (worth $1,000) in your $1,000 account, you are using NO leverage. 1:1 = NO leverage.
If you trade 2 micro-lots (worth $2,000) in your $1,000 account, you are using 2:1 leverage, because your position is 2 times as large as your account balance.
In each case, the leverage you actually use is determined by you, when you determine your position size. It has nothing to do with the maximum allowable leverage (100:1) specified by your broker, as long as it is less than that maximum.
You can continue this exercise for any position size, and determine in each case what leverage you would actually be using.
You will hit the 100:1 leverage limit imposed by your broker when you try to trade 100 micro-lots (worth $100,000) in your $1,000 account.
Whenever you place a trade, your broker will designate a margin amount, based on (1) your position size, and (2) the maximum allowable leverage provided to you.
You can calculate the margin amount for trades of various sizes: $10 margin on 1 micro-lot, $20 margin on 2 micro-lots, etc. (based on the 100:1 maximum allowable leverage we are using in these examples).
A prudent trader has no reason to fear high maximum allowable leverage. Suppose your broker offered you maximum allowable leverage of 1,000:1? Or 10,000:1? Would that have any effect on your account, or on your trading? It should not.
As a prudent trader, you would still structure your trades based on limited risk — say, 2% of your account balance.
Even if you were able to limit your risk per trade to [B]just 10 pips[/B] (which is very hard to do), your 2% risk rule would allow you to trade no more than 20 micro-lots in your $1,000 micro account. In other words, [B]20:1 actual leverage used[/B] is about as high as you could possibly go, without violating your 2% risk rule.
Given a $1,000 micro account, and a 2% risk rule,
[ul]
[li]a 15-pip trade risk corresponds to a 13-micro-lot position size, and 13:1 actual leverage used
[/li]
[li]a 20-pip trade risk corresponds to a 10-micro-lot position size, and 10:1 actual leverage used
[/li]
[li]a 30-pip trade risk corresponds to a 6-micro-lot position size, and 6:1 actual leverage used
[/li][/ul]
In these examples, it didn’t matter, at all, whether you broker allowed you UP TO 100:1 leverage, or 1,000:1, or 10,000:1.
Your [B]actual leverage used [/B]was determined by prudent risk control.
Since I didn’t understand your questions in the beginning, I can only hope that I have answered them.
I was mixing up things even though I had somewhat good understanding of the concept. But now, with all your explanation, crystal couldn’t be any clearer.
