I sort of understand how leverage and margin work, but I think I’m still missing something. Suppose I open a micro account (trading 1K lots) with $100. I always set S/L at 30 pips. At $0.10 profit/loss per pip, that means if I lose a total of 1,000 pips I am busto. What I dont understand is, what difference does it make whether I have 400:1 leverage, 100:1 or 50:1? I know it means that either $2.50, $10 or $20 will be set aside in my account for each trade, but does it really have any effect on my trading or chances for success? 1000 pips is still 1000 pips right?
That’s right. However, with leverage, you can increase the number of trades open at the same time, and/or the number of lots per trade.
So for example if you have 2 lots on a trade, now you would go bust in 500 pips, 3 lots in 333 pips, 4 lots in 250 pips…etc…and of course the broker holds x $ of your account for each lot, not just per trade.
If you had 2 or more trades open, each with 1 lot, then you have to balance the total pip loss (risk) across all trades combined, and again the broker holds back x $ of your account for each trade. Here tho, with 2 trades, 1 trade could go 900 against and then the other could only go 100. If you had 3 trades, 1 could go 500 against, then the other 2 could only go 250 each, kinda thing.
Hope that helps 
my understanding on the situation is that there are two types of leverage … margin leverage, which is what your broker sets aside according to your ratio … and account leverage, which is how much of your account you’re willing to risk on any given trade.
Of the two, the latter is the most important to be mindful of as it will be the one that ultimately makes or breaks your account.
For me, margin leverage is important as it defines how many “bullets” I have in my gun. ie. if a position goes against me and I want to average in, I need to have capital available to open additional positions. If I have lower margin leverage, then it reduces the number of positions that I can add and how much drawdown I can accept in between positions.
Thanks for replies. I see people being worried about being overleveraged and increasing the risk of getting a margin call, but I dont see how higher leverage can increase the chances of margin call happening.
If you had a $1k mini account and put on 10 lots (= 1 std lot = $10/pip), then you can only go approx -100 pips to equal -$1k. Then you’d get a margin call…some people do that…lol.
However, sounding like a sensible person, you can understand that is not a good thing to do, but many others don’t…they think in +100 pips they can double their account…and they only had $50 on hold.
nUmbnUts,
I think you are right…there is a perception that too much leverage is a bad thing, and yup, in the hands of a fx maniac it probably is.
It is all semantics that makes a really simple concept very complicated(IMHO)…if you are going to risk losing 2% of your account on a trade, then the leverage that this is done at means nothing, zero, zip and to try and say that there was one iota more risk because it was done at 1:500 rather than 1:100 is incorrect. Purists will tell that the true leverage was only 1:10(or whatever) if you were only risking 2% of your account…sure it was…semantics and all.
I believe that leverage is not important to traders that have sound risk management in place and do not take excessive risk, but in the hands of a newbie that has not felt the cruel whip of a margin call, it beckons like a spider to a fly.
The higher the leverage the more money 1000 pips is worth.
That works both ways, you can make faster profits but you can also make faster losses for instance if you increase your leverage so that 1 pip = $10 you only have to go ten pips negative to wipe out 100 dollars, where as if you have lower leverage so that 1 pip = 1 dollar you would have to go 100 pips negative to wipe out 100 dollars.
You will find when trading, leverage is not an issue, for example my account is a standard account trading 10k lots so 1 pip = 1 dollar but if I want to I can make my trades the same as your mini account just by typing 0.1 in the lot size box when I open an order, so then instead of trading a whole 10k lot I’m trading 0.1 lots so 1 pip = 10cents.
In the same way I could trade 5 lots on a position so 1 pip would be five dollars.
The thing about leverage is that you can use it ALL risk free, some of the time.
I know that sounds ridiculous but I can explain it really quick in a minute or two.
Every time you can move your stop loss to breakeven, you are actually taking the risk off the table. But you still need the margin available to hold the positions. Now if you open a series of trades/positions, and the market gives you the opportunity to move stops to even, then you can completely max out your leverage without risking a dime (other than the profits you are holding already).
Also think of it this way, infinite potential for reward, with zero risk. There’s the risk of slippage, but this is less of a concern for higher timeframes.
So more leverage lets you take advantage of that “little trick” to a greater extent. Also, as your profits increase, it gives you more usable margin to add more. Personally I think big banks are doing this every day, that’s why markets form those parabolic-shaped trends, as the paper profits on the banks’ desks swell up with the power of leverage. Their risk of slippage is much greater however because they are dealing with massive billion dollar positions, which are harder to liquidate on the spot.
Whether the MAXIMUM ALLOWABLE LEVERAGE offered by your broker affects your trading depends on how you trade.
Refer to the example worked out on JSchay’s thread: 301 Moved Permanently
In that example, a conservative trade was structured in which 9 micro lots (9,000 units of currency) were traded with a $1,500 micro account, and trade risk was limited to 2%.
Actual leverage used in that trade was 6:1 (calculated as $9,000 position / $1,500 account balance). So, for that trade, even the ridiculous 10:1 leverage proposed by the CFTC would be okay.
But, suppose JSchay wanted to place that trade, and another similar (but uncorrelated) trade, at the same time. His intention would be to have two uncorrelated trades open, each one representing risk of 2% of account value. His total open position risk would then be 4% — but, because his two positions are uncorrelated, a loss in one position would not necessarily imply two losses.
With 2% risk in each position, and 4% risk in both positions combined, his money management would still be regarded as very conservative. But, if 10:1 leverage were the government-imposed LIMIT, then he would not be able to put on these two positions. Two positions, totalling 18 micro lots, would require $1,800 in margin by law (and that wouldn’t allow for spreads or losses).
In order to trade two positions of 9 micro lots each, with 35-pip stop-losses, JSchay would need more than $1,857. in his micro account, just to cover the higher margin requirement plus 2 possible losses.
Now, consider a scalper who limits losses to 10 pips maximum on each trade. Let’s say this scalper has a $1,500 micro account (like JSchay), and let’s say he’s scalping the same USD/CHF pair that JSchay is day-trading (or swing-trading).
JSchay risks 2% of capital using 35-pip stop-losses, trading 9 micro lots per trade.
Our scalper buddy risks 2% of capital using 10-pip (mental) stops, trading 33 micro lots per trade.
But, the CFTC’s proposed 10:1 leverage limit would not allow the scalper to continue trading as he has been doing. In order to trade 33 micro lots, he would need to deposit more money into his account to bring it up to $3,300 (PLUS allowance for possible losses).
So, at some point, MAXIMUM ALLOWABLE LEVERAGE does matter, in terms of capital required to trade.
And it matters from another standpoint: it isn’t the proper business of the government to micro-manage the lives of forex traders, or of any other citizen.
So, let’s say the CFTC’s 10:1 leverage limit is defeated. Does it matter to forex traders whether their brokers offer 100:1 or 200:1 or 400:1 maximum allowable leverage? To any reasonably prudent trader, it does not.
Maximum allowable leverage is a little like the credit limit on your credit card. If you charge a few thousand dollars each month, and pay off your balance each month, the $50,000 credit limit on your Platinum Visa card may be meaningless.
And then, if your credit card company decides to make a big deal out of replacing your Platinum card with a new Plutonium Visa card, with a credit limit of $100,000, you’d probably just laugh.
Most likely, actually using a $100,000 credit line on your credit card doesn’t figure into your lifestyle.
In the same way, actually using 100:1 or 200:1 or 400:1 leverage in your forex account shouldn’t figure into your trading style.
Hello,
I’d like to ‘butt in’ here simply because this is something that took me an AGE to understand myself!!!
I think that Clint (as always) has addressed ALL the ‘issues at hand’ as well as all the other posters before him. I guess I’m just going to ‘put things another way’ is all.
High leverage in and of itself is not a problem. It’s when high leverage ‘meets’ with ‘the human factor’ that the problems arise!!! As has been noted: it does not matter what your leverage is: it is as long as you don’t risk more than 2% (or whatever your ‘poison’ is) of your account on a trade that matters and is ‘all important’. That being said: with high leverage you need less margin per position so ‘the human factor’ (if not ‘kept in check’) will have a trader open FAR more positions than they would have been able to open with lower leverage and, by the time they look again, even although their total exposure on ONE trade may only be 2%, they may be risking 80% of their account at any one time simply because they CAN i.e. simply because of the high leverage they are able to open WAY too many positions at once whereas with lower leverage they would not be able to do this.
It’s funny that Clint used credit cards as an example i.e. just this morning in an e-mail to someone I was saying that I regard leverage as ‘credit’ and we all know how bad ‘credit’ can be for some people (myself included)!!! In other words: how many people get a credit card with, say, a $5 000 limit. They can afford to pay the installments on that $5 000 limit. But then they get given a new credit limit of say $50 000 simply because they’ve been a good and regular payer on the $5 000 limit. NOW however: there is NO WAY that if they ‘maxed out’ that $50 000 that they’d be able to afford the monthly installments but ‘human nature’ being what it is (for all but the most ‘together’ of all of us) they WILL spend that $50 000 using all manner of justification for doing it ‘just because they can’. The same thing with leverage i.e. a trader may open far too many positions ‘just because they can’ due to high leverage and therein lies the problem and, to make matters worse, they’ll be able to justify opening every single one of those positions even after they’ve all ‘gone south’ and 80% of the account is gone!!!
One other thing: the amount of leverage does NOT affect your $ value per pip / tick. Your LOT SIZE is what determines this. But in a ‘round about way’: leverage CAN affect your $ value per pip / tick value BUT ONLY BECAUSE you can open larger (than prudent) positions in relation to your account size BECAUSE of the higher leverage and THIS is ‘the leverage trap’!!!
As I say: I’m obviously repeating what’s already been said but this is the type of explanation that would have made sense TO ME back then!!!
Regards,
Dale.
I regularly risk more than 2% of my account I don’t see how anyone can make any money risking only 2% for instance take the aforementioned $100 micro account:
Trading 1k lots at 100:1 leverage, 1 pip = 10cents
2% of $100 = $2
20 pips = $2
Therefore you would have to set your stop loss at 20 pips.
If I set a stop loss at that ratio I would get stopped out on nearly every trade I enter due to minor price fluctuations, it would be almost impossible to trade hourly charts, the price fluctuations in 1 candle are usually way more than 20 pips. Even the 15 minute charts would eat you alive.
What about position size? Don’t forget: [B]Risk = Stop Loss x Position Size[/B] regardless of pip value.
Lot size is directly propertional to position size, the point I was making was, you don’t need to worry about the leverage, you can adjust your risk while trading by adjusting your lot size.
Its just easier that way as you can enter the lot size you want to trade as you fill your orders.
Examples: The dude with the $100 micro account on 1k lots wants to trade at 1 cent per pip he sets his lot size at 0.1 if he wants to trade at 50 cents per pip he sets his lot size at 5.