Hi Guys,
I’m new to forex trading and have just started to read up on it on babypips and plan on as much study as I can before I risk any real money. My main concern is to “dig a hole I cant get out of”
I’m going through the lots leverage and loss lesson and have a question about how exposed you can be when using leverage.
The lesson shows a good example for a profit, what I would like to know is what is the risk for loss on a similar example. Suppose a trade goes horribly, horribly wrong. As in 2012, end of the world, money becomes obsolete back to trading shiny rocks wrong.
So for example, if I had $5000 in my account and put down $1000 deposit at 100:1 leverage and bought 100 000 US dollars. A few hours later the trading world ends and I end up losing $30 000 of that $100 000. Does that mean I have lost $300 of my $1000 or does that mean that I also lose money out of my $5000 that I did not trade and could also be in debt for a further $25 000?
Of course I would hope that no real trade would go this wrong and stop loss orders would prevent this sort of loss.
I realise this may sound a silly question to some but any help for the newbie would be apprecriated!
So for example, if I had $5000 in my account and put down $1000 deposit
I am not sure I understand this. do you now have 6000 in you account and trade a 100,000 size? at 100:1 you would use 1000 in margin. now you have 5000 or 4000 left to lose depending on if you started with 5000 or 6000.
The broker will try and stop your trade before you lose all of your money. Thats a margin call. This is in the brokers interest they don’t want to chase down people to pay up big losses. Exactly when your broker stops you out is usually explained in the agreement you sign when you open an account. Also there is always a warning about the fact that if the broker can not close you out you may owe more then your starting balance. I am sure this could happen but it has to be very rare.
No broker in there right mind would offer leverage anywhere near 100:1 if they thought it likely they would often fail when executing a margin call stop out.
leverage is only a tool to decide the max position size you can open.
now, your example is that you have 5000$ equity. and that you open a 100.000$ position ( 1 standard lot) using part of your equity as margin ( 1000$ in your case with 100:1 leverage)…
what do you have left is 4000$ free margin.
your end of world scenario doesnt put into consideration any StopLoss order, so, now go along that.
Your position’s value change with every pip move, in this case 10$/pip…
since you have a total of 5000$ equity, it might mean 500 pips change before the account run down to zero (0$)…say might, as many brokers close out positions before this happens, each has the margin call or force liquidation rules in their TOS.
so, what happens is that your position of 100.000$ moves 1% only, then due the leverage of 100:1 it equals to 100x the move, ie you already lost your 1000$ you opened the position, and then if you keep the position on the further losses deducted from your free margin/current account balance.
a 1% move very common within a day.
If you dont want to lose such amount, or your account, then use some StopLoss order, to limit your max loss, or simply trade smaller positions, where 1 pip’s value is less. about money management suggestions there is plenty of topic, the magic number usually the 2% risk of equity.
in your case that is 100$/trade…thus opening 1 lot it comes that you should have a SL in 10 pips, while for example if you only open a 20.000$ position, you could use a 50 pips SL as maximum, a more reasonable amount, if you not scalping, but trading.
sorry if a bit long, but feel like you are newbie to these, so, try to make it simple to understand.
Well, it’s not a silly question. It just makes good common sense to understand worst-case scenarios, when you’re risking your money (or playing with hand-grenades).
To continue with your example, let’s say that you enter a LONG position in the USD/CAD at parity (USD/CAD = 1.0000).
I cleverly picked this pair because parity makes the math simpler.
Here’s what we know:
Your position is $100,000
With 100:1 allowable leverage, the margin required on this position is $1,000
As price moves, each pip is worth $10 to you (because you are trading 1 standard lot)
You’re a newbie, so let’s say you forgot to protect your position with a stop-loss
(I know, I know, you would NEVER forget to use a stop-loss — but, humor me)
Continuing with your example, the world is hit with some terrible catastophe. The USD becomes worthless, the USD/CAD plunges to 0.0001, fortunes are lost, and people are jumping out of tenth-floor windows.
Your broker has miraculously survived the catastophe, and is now trying to collect “money owed” from his customers. You are contacted by this fine fellow, who tells you that you were margin-called at USD/CAD = 0.9600, but the market was collapsing so fast that your position was actually closed at USD/CAD = 0.0001
“Unavoidable slippage in a fast-moving market,” he says.
You now owe your broker $94,990, calculated as follows:
You were margin-called at 0.9600, at which point you had lost $4,000 of your $5,000 account, and only your $1,000 margin was left.
But, your position was not closed, because the End of the World was screwing up all the world’s computers
(or some other lame excuse), so your losses continued to mount.
At USD/CAD = 0.9500, your last $1,000 had fallen into the black hole; and from there on down, you were losing money on the broker’s dime.
At USD/CAD = 0.0001, you had accumulated another 9,499 pips of loss, which is $94,990 to you (at $10 per pip).
How do you want to pay that: cash, certified check, or credit card?
I made this scenario as extreme as possible to illustrate a couple of points (well, three points, actually):
[B]1.[/B] There are no daily limits on spot forex positions, like those on futures contracts. On futures exchanges (at least, here in the U.S.), a price can drop no further than the daily limit, at which point the price is said to be limit-down. It can stay there until tomorrow, at which time it could open limit-down again…
But, the idea behind daily limits is to give chaotic markets a chance to overcome panic, and regain their footing. No such mechanism exists in spot forex. So, it’s [I]possible[/I] (but highly unlikely) that some world-altering event could drive one or more currencies into oblivion, almost instantaneously.
[B]2.[/B] In the scenario above (which is ridiculous on several levels), the dollar has collapsed to zero, but your broker is still alive, kicking, and wearing his debt-collector hat. His computers and telephone seem to be working just fine. He seems to think the banking system can handle your payment of $94,990 (by the way, how did you say you want to pay that?). And he seems to think the courts will be able to handle his claim against you in the event that you can’t or won’t pay him $94,990 (on second thought, he’d like to have that in gold bullion, if you don’t mind).
As a practical matter, your broker would probably have been wiped out in the same calamity that wiped out your account. And it would probably be a very long time, if ever, before a court-appointed trustee attempted to reconcile the broker’s books.
[B]3.[/B] This is the most important point. Your failure to put a stop-loss in place hurt you in at least two different ways. (I know, it wasn’t you; it was that other newbie.)
First, if you’d had a stop-loss, it might have been executed at the price you specified, saving you ALL the grief described above. Or, after some really nasty slippage, it might have been executed at a much worse (lower) price than you specified — but, still a hell of a lot better than “down $94,990” (speaking of which, your broker wants to know where his gold bullion is).
Second, when the court-appointed trustee comes looking for you, you would have a much stronger case against the broker, if you could argue that he mishandled BOTH your stop-loss and your margin-call.
Okay, let’s get back to reality. The End of the World (or even the End of the World As We Know It) is uncharted territory. Nothing like that has ever hit the retail spot forex market — which is the market we trade. The biggest shocks to the forex market, in its brief existence, have been the terrorist attacks on September 11, 2001, in New York, and on July 7, 2005, in London; and the financial crisis which began in 2007. You can pull up price charts and see the effects of these crises on various currency pairs. As bad as those events were, they didn’t come close to the End of the World scenario you are wondering about.
So, your question is valid. But, answers to it are highly speculative.
The U.S. CFTC requires every U.S. forex broker (the CFTC calls them RFED’s) to disclose specific risks to prospective customers. One of the risks requiring disclosure is that you, the customer, can lose all of your account, and — under certain circumstances — you can lose MORE than all of your account. The CFTC doesn’t say how likely, or unlikely, that might be.
Nor do they say how likely, or unlikely, the End of the World might be.
Well put, that’s all you need concern yourself about, how many points is your stop and how many ‘lots’ you’ve put on per PIP, simple - that is all the calculation you need to do, it’s always ‘lots’ multiplied by PIPS, that is all, nothing more nothing less - don’t overcomplicate it.
there is a little more, if you like to trade not only 1 position a time, but multiple, then it does matter a lot your leverage, else you wont have the margin to open trades.
if you trade 1 position a time, agree, it doesnt matter.
Wow lots of good answers. Thanks a lot guys for the help.
So basically a stop loss prevents you losing more than you plan to, and you will be margin called if you lose too much on a trade and these should be executed more or less instantaneous in normal market conditions.
But without these two safeguards you could theoretically lose more if you werent careful.
Some brokers guarantee that the maximum lose you can have is the amount you have in your account. i.e. They will close all your positions if your trade happen to lose more than what you have in the account. I’m new to forex too.