Why is high leverage a concern if stops are in place?

This may sound like an obvious question, or a dumb one, but can someone explain why it’s better to go lower leverage of say 10:1 instead of 50:1? They say the higher you go, the more risk you incur, but if you have a stop loss in place to never lose more than 1% of your account balance on any one trade (i.e. £100 on £10,000 account), what is the concern?

Thanks.

Discipline.

If you use leverage properly (like you’ve outlined), you’d be fine. But if the trader isn’t disciplined & they’re over leveraged & under capitalised then it’s an easy way for them to bust an account.

Slippage.

Suppose you have a 20 pip stop worth $50 ($2.50 per pip). Your account is worth $5,000.00 so you are only risking 1%. Very safe right? Nope. Suddenly, the next crisis breaks and the pair moves against you. Your stop is triggered and in the moments of illiquid horror, you are stuck in the position while the internet goes crazy with tweets and fb updates of “Holy Shix!” Then, liquidity returns and your stop is filled 962 pips below the trigger level. So now you lost 982 pips at $2.50 a pip ($2455.00). Forty nine percent of your account is gone in a morning.

This is not so much a problem of leverage, rather of the proportion of your account value that was fixed to the given market. The solution is to spread your risk out into other markets so as to minimize the effect of any single market blowup.

Use maximum leverage in an account that will likely give you negative balance forgiveness under circumstances of a market crisis and keep the bulk of your trading capital in a more safe account with a bank and spread your risk over many markets to avoid the sudden crush from wicked slippage.

-Adrian

I didn’t realise slippage was such a factor here. I knew it could happen in stocks which I used to trade, but I thought the market here was so liquid that our orders would be filled instantly in such an event. That’s not good news to hear :frowning:

[QUOTE=“tehmac;719406”]That’s not good news to hear :-([/QUOTE]

You unintentionally hit the nail in the head there: it’s news releases (NFP, interest rate hikes etc) that are going to cause the sudden fast moves in the market - wide spreads & slippage ahoy!

Is it possible to always miss these slippage moments? Where is the best place to monitor when all announcements/news might occur. Is there sometimes ‘out of the blue’ announcements that aren’t at the monitored times that can cause devastation and slippage? Thanks.

Only way to avoid them is to close all positions prior to expected news announcements, even then a surprise (terror attack, tsunami) could wipe you out.
And dont forget weekend gaping!

BabyPips has its own Economic Calculator, it’ll tell you when the releases are & their importance.

http://www.babypips.com/tools/forex-calendar/

Things can happen out of the blue though. Back in January the Swiss Franc was unpegged & the move was massive. There’s a thread on it pinned at the top of the Forex Town section of the forum. Brokers were losing hundreds of millions (some going bust). The screen shot is below: it moved 1500+ pips in minutes & look at the gap. I’m out & about just now so forgive the phone screenshot but feel free to look it up yourself (15/01/15).


When you say ‘use maximum leverage in an account that will likely give you negative balance forgiveness’, does this imply use the smallest amount you’d be okay with losing and have only that amount in the account, and work it up, then maybe extract it and deposit more and do it again with a smaller amount. i.e. instead of £10,000 in the account, you only put £1,000 in and work it up to x amount, then extract it, and maybe deposit £3,000 in and work it up etc. Isn’t this similar to the Larry Williams strategy I’ve briefly heard about? In some ways it makes sense, but it does mean your amounts you’re working with are far smaller than if you had your full balance in there.

I had a funny feeling that I had a picture saved on my iPad too. Look at this daily candle compared to all the others & as I said in the previous post, this was out of the blue & took place in minutes (if even).

Edit: Oh well, removing my January balance from the photo didn’t work. Have 2 photos instead - sorry.



We also had some massive jumps/drops last week when the Dow opened 1100 points lower.
The GBP/NZD went from 2.4000 to 2.5300 in minutes, other currencies had similar moves

Those are some scary looking charts. Hypothetically, if I my maximum to put in was £10,000, then I risk losing it all in the blink of an eye if the above were to happen, so maybe it is better to put in a smaller amount I can risk losing in one go if the worst were to happen and try to build it up (say £500 or £1000). Remove some later once built up, then put in a little larger amount, but still only a % of my full capital. Is that what people do for safety?

I’m also very confused regarding the figures. I stuck £10,000 in a practice account, and I was using the following position size calculator for all my trades. It was very straight forward. Position Size Calculator | Myfxbook I put in the amount I was willing to risk, my capital, the stop loss distance, and it told me how many I could buy.

However, now that I’ve tried the practice account with only £500, that position size calculator doesn’t seem to fit my needs. It tells me I can trade way more than I can with my £500 and my margin shoots higher than my balance. My free margin was also negative. I would have thought it wouldn’t have let me place the trade in the first place.

Leverage should never be a concern because it is your choice if you want to take it or not. I don’t see any good reason why would you not take higher leverage when there is going to be higher trading freedom provided from it.
The risk exposure is up to the traders, no matter what leverage they are using. If you have a good risk management than leverage by it self will provide you with higher earning opportunities.

I think the issue I’m suffering from is that on some trades yes I’ll have a standard stop size of maybe 40 pips or something if I’m trading the hourly, but for some of my entries, I have a very tight stop of 10 pips just before the previous candle as I’m confident of my entry. But putting this stop loss pip distance into the position size calculators, it is telling me I can trade a size significantly higher than is allowable by my small balance, even with 50:1 leverage. I end up with negative free margin showing if it does go through. How can I account for this? The math is hurting my head!

Thanks very much for all the help folks.

Slippage of 960 pips? Jesus what broker is that!

The screenshots are from Oanda but that would be pretty similar across the board on all the various broker’s charts. As I said before, brokers themselves lost millions - I think it was FXCM that lost £225 million. Some even went bust.

It wasn’t a broker issue, it was just that volatile of (unscheduled) news release.

Hi tehmac,

many people do not know the difference between “maximum leverage” and “actual/used leverage”. If you interpret both what they mean, you will be able to answer to your own question!

Hi Baz,

Despite the events of January 15th, FXCM’s capitalization remains at levels similar to before the SNB event and in excess of what is required by global regulators.

Furthermore, all of our regulated entities outside the US provide clients with segregated funds. Our UK-regulated entity through the FSCS even offers clients £50,000 per person in protection. Canada has similar insurance for retail traders of up to $1 million CAD.

For US traders, below are the latest capital figures for our US entity as compared to all other US-regulated forex brokers (RFEDs) as reported to the CFTC.

We pride ourselves in continuing to provide our clients with the same level of service and support to which they are accustomed. Our customer equity grew by $68 million or 10% the last quarter. While $47 million of that increase was due to our acquisition of CitiFXPro, the remainder was organic. It’s a strong vote of confidence that Citibank chose FXCM for its customers when they decided to exit the business in June.

Yes. If you have 10,000 to trade, and you have a dealer that will give you 50:1 leverage, then a deposit of 200 with the dealer would enable you to trade that 10,000 with a maximum risk of 200. If you deposit 1,000 with the dealer and keep 9,000 at home, you can trade 50,000 worth of currency (5 times your total capital) with just 1,000 at risk (10%). So use leverage not to trade so heavy that you risk a blow up, but rather use it to minimize risk.

There is something else of great importance: if you have 10,000 but only 1,000 on deposit with your dealer you can trade fixed fractional position sizes of the amount on deposit with the dealer. So with that example you could decide to risk 2% of the account balance per trade which is 20 (2% of 1,000 is 20). But that is just 20 basis points (.2%) of your total capital (20 is .2% of 10,000). And suppose after a string of losses your deposit is down to 500. Then you would risk 10 (2% of 500 is 10) which is only 10.5 basis points (10 is .105% of 9500). Thus as you lose money your total trading capital approaches 9,500 asymptotically. If you risk a fixed fractional amount of your whole capital then your balance approaches ZERO asymptotically.

I wrote about this phenomenon here:

Arbitrager on Acid - ARB/LSD: FIXED FRACTION OF PREDETERMINED MAXIMUM ALLOWABLE DRAWDOWN POSITION SIZING ALGORITHM - A VARIABLE % RISK PATTERN

-Adrian

Most of them. And if your money is on deposit with one that goes bust despite your individual good risk management you are still fuct.

-Adrian