Hi all,
I’ve reviewed the material here at babypips and even read posts on the internet about this topic, but no one seems to lay out the details of an entire trade transaction of used margin, usable margin, pip move prior to account cleanout, etc, in such a way that I can follow.
I have written up a scenario below and have attempted to provide a complete analysis of an account size, a EUR/USD trade example, margin requirements, used margin, what would it take for me to lose all my money, etc. Can someone take a look at my logic and calculations and let me know if I’m on the right track? THANK YOU VERY MUCH!
For simplicity purposes, I’m going to ignore spread costs.
Let’s say I open a Forex account that trades standard lots (1 lot = 100,000 units), with a leverage ratio of 50:1 (aka 2% margin requirement).
I have $10,000 in my broker account.
I decide to trade the EUR/USD currency pair @ 1.3500.
This means that 1 EUR can purchase 1.3500 USD (EUR is worth more than the USD).
I expect the EUR to increase in value compared to the USD, so I would be buying the EUR, hoping that the rate will go above 1.3500.
To trade one standard lot, I would be buying 100,000 units of EUR. To pay for it, I will be using USD. At the current rate of 1.3500, the cost would be $135,000 USD.
Since my broker has a 2% margin requirement, I will need to fork up $2700 USD for this one standard lot.
After this transaction, I will now control 100,000 units of EUR with only $2700.
My used margin will be $2700 and my usable margin will be ($10,000  $2700) = $6300.
If the trade goes in my favor, then great.
However, if the trade goes against me, then I have the following questions:

How many pips of movement in the currency rate, will it take before my used margin of $2700 will be wiped out.

Also, how many pips of movement in the currency rate, will it take before my usaable margin of $6300 is also wiped out?
I’m actually unsure how to calculate the above, but here is my attempt.
First, in the extreme case, if my leverage ratio were 1:1, I would have had to fork out $135,000 of my own USD to take this trade.
If the currency rate then dropped from 1.3500 to 1.3000 (a 3.7% drop), then that simply equates to a 3.7% loss on my $135,000, or in other words, I would have lost (3.7% x $135,000) = $5000.
This makes sense, because a drop from 1.3500  1.3000 = 500 pips, where the cost per pip for a EUR/USD currency pair is $10/pip; i.e. $5000.
Now, this is if my leverage ratio were 1:1.
However, my broker is nice enough to give me a 50:1 leverage ratio. At this leverage ratio, if the currency rate dropped from 1.3500 to 1.3000 (which is a 3.7% drop), then the effect that it will have on me is not the full $5000 of loss, but a whopping 50 times that, or ($5000 * 50) = $250000.
Of course, this is something I cannot sustain with my meager account size.
Thus, the pip movement that will clean out my used margin of $2700 must be much smaller than 500 pips.
To calculate the pip movement that will clean out my used margin of $2700, I think I have to do this:
($2700 / 50) = $54
This $54 is a loss that I would typically sustain if I traded with a leverage ratio of 1:1. In that case, $135,000  $54 = $134,946.
That is, if the currency rate dropped from 1.3500 to 1.34946 (which is about 5 to 6 pips), I can pretty much say bye bye to my used margin $2700.
Then, I will have $6300 of usable margin left to try to save my neck.
Following the same logic:
($6300 / 50) = $126
Again, this is a loss that I would typically sustain if I traded with a leverage ratio of 1:1. In that case, $135,000  $126 = $134874.
That is, if the currency rate dropped further from 1.34946 to 1.34874 (which is about 7 pips), I can pretty much say bye bye to my remaining usable margin of $6300.
Thus, tallying up the total pip movement, if the currency rate drops a mere 12 or 13 pips against me, then my account of $10,000 would be cleaned out.
Somehow, the above analysis seems awfully wrong, since a 12 pip move seems awfully small to clean out a $10,000 account.
Can someone let me know if my logic and calculations are correct and if not, where did I fumble?
Thanks for your help guys and gals!