If I were to open a position of the same size in, for example, an account with 1:20 leverage and one with 1:50, would there be any difference at all for when a margin call is issued or other bad things happen? Or wouldn’t it hurt to have an account with super high leverage as long as you don’t make use of it?
You’ve asked two very different questions. Let’s separate them, and sort this out.
For this question, you need to think of terms of margin. Leverage of 20:1 means that required margin [I]to open a position[/I] is 5% of notional value. Leverage of 50:1 means that required margin [I]to open a position[/I] is 2% of notional value.
Example #1.
You want to know where the limits are. So, let’s assume that you open a maximum permissible position in the account requiring 5% margin. An example of this would be a one-mini-lot position in USD/JPY in an account with a $500 balance. In this case, every dollar of your account balance would be required to satisfy the 5% [I]initial margin requirement.[/I]
Now, let’s assume that your broker’s margin-call policy is such that when your equity falls to 50% of initial required margin, your position will be closed automatically, without warning (a margin-call, in other words). This 50% level is commonly referred to as the [I]maintenance margin requirement[/I] (as distinct from the initial margin requirement). So, if your USD/JPY position goes badly against you, resulting in a loss of open equity of $250, you will suffer a margin-call. At that point, your position will be closed, and your remaining equity of $250 will become your new account balance. (Note that the spread cost is included in the $250 loss described above.)
Example #2.
If you placed this same trade in your “other” forex account, which has a 2% initial margin requirement (and assuming a 50% maintenance margin requirement, as before), then when you open the USD/JPY trade (one mini-lot, as before), only $200 of your $500 account balance will be committed to [I]used margin,[/I] and the remaining $300 (referred to as [I]unused margin,[/I] or [I]available margin[/I]) will be available to you for other uses, including covering losses in your USD/JPY trade. So, in this case, your USD/JPY losses would have to consume all of your $300 in unused margin, plus 50% of the $200 required initial margin, before you would suffer a margin-call. In other words, you would have to sit through a $400 loss in your position (including the spread cost) in order to trigger a margin-call.
In Example #1 (with 20:1 leverage and 5% required initial margin), a $250 loss triggers a margin-call, after which your remaining account balance would be $250.
In Example #2 (with 50:1 leverage and 2% required initial margin), a $400 loss triggers a margin-call, after which your remaining account balance would be $100.
Both of the examples above illustrate [B]how not to trade,[/B] because in each case, risk is not being managed. Any trade in which normal trading losses can consume a sizable portion of your total equity — is a crap-shoot. There is no risk management in either of those examples.
In each case, the actual leverage being used was 20:1. And that’s way too high for most forex traders (experienced scalpers being a possible exception), and it’s way too high for newbie traders (regardless of trading style).
Actual leverage in the range of 5:1 is much more appropriate for most forex traders, provided they diligently manage risk. And risk can be managed without regard to the amount of actual leverage you are using. In other words, if you properly manage your risk on every individual trade that you place, and on the total basket of trades you have open at any one time, then you can ignore the amount of leverage you are actually using. Actual leverage used will take care of itself.
Proper risk management involves determining the maximum loss in pips which you will tolerate on each trade you place, and then adjusting your position size in that trade to make that pip-loss equal a pre-defined dollar-loss. Many traders use 1%, or 2%, as the maximum tolerable dollar-loss on any one position, and 5%, or less, as the maximum tolerable total loss, if all open positions are stopped-out.
If you practice good risk management, then the leverage you are actually using (as distinct from the maximum allowable leverage offered by your broker) will take care of itself.
As a learning exercise, run some numbers based on hypothetical account balances, required margin, stop-losses, and position sizes. Use a position size calculator. See what will happen if you risk 1%, 2%, 5%, 10%, or 50% of your account balance on a single trade. In each case, observe where a margin-call would occur, as we did in the examples above.
In general, the more broker leverage (maximum allowable leverage) you can get, the better. I have frequently said that I would choose 10000:1 broker leverage, if it were offered to me — because that leverage number affects only the amount of my account which is set aside as margin in each trade. It has nothing to do with the way I trade. It has nothing to do with the risks I take. And it should be one less thing to think about.
The most important thing is risk management. Does not matter what leverage you have selected on your account, go as high as you can. Many think leverage blows accounts which is incorrect. The absence of risk management causes the problems.
That was very helpful. I just didn’t want to suddenly see a margin call before my stops are hit, if that is even possible with reasonable stops and positions.
Leverage is like its name, you can trade higher volume with smaller fund. And when you trade at higher volume, its movement can create m impact on your account.
I also found this link that I see it could be helpful for your issue.
Position Size Calculator
The higher is leverage the less should be your capital to open particular position. Not considering size of the position leverage in fact is a multiplier of profit&risk factor that applied to your N amount of money when you trading FX.
Forgot to answer your last part, it’s ok to have higher leverage account, doesn’t matter if you trade small volume.