It has been a long time coming, but I want to discuss the use of leverage in trading. It is so important that we fully understand exactly what the risks are.
So what is the problem with leverage?
Leverage allows you to take on LARGER positions with the same margin, but the distance your Stop Loss can be placed will be shortened with high leverage, or lengthened using lower leverage.
$1000 can control 1,000,000 units of the base currency of the pair, when using 1000:1 leverage, or $100/pip
$1000 can control 100,000 units with 100: 1 leverage, or $10/pip.
$1000 can only control 10,000 units with 10:1 leverage, or $1/pip.
To understand this issue, it is easier to take a look at the extremes.
Imagine you have 1000:1 leverage, trading FULL contracts, not Mini’s.
This means you can control 100,000 units of the base currency of the pair, for only $100.
It also means that if the exchange rate rises by 10 pips, and you are “long”, then you will be credited with $1000.
Similarly you will be debited $100 for every one-pip move against you, or you will lose $1000 for a detrimental 10-pip move.
Heady stuff indeed.
Clearly you can now see that an account of $10,000 could only sustain a 100-pip loss before wiping out, at 1000:1 leverage.
But this is not the only problem: If you want to trade using a stop, you will have to submit a margin to fund your position - that is mandatory. At 1000:1 a 10-pip stop-loss order will require $1000 margin, and a 50-pip SL will require $5000. That leaves NO ROOM for money management whatsoever - where is your “2% of account per trade” now?
You can not do it using such leverage, unless you have a VERY large account, and the brokers who offer high leverage know this. Traders use it because it is offered, not in any way understanding the implications of the leverage they are using.
In my view, this is criminal, but traders need to take responsibility for their own accounts, and do the hard work - the head work - necessary to fully understand leverage and the judicious use of it in trading forex.
It is my view, that not one in 20 traders understand this anomaly - probably far fewer than 5%.
Currencies move 10-pips before yawning! Unless you are lucky enough to get an initial move in your favour, you are gone. Most 5 minute charts show “noise” of 10 pips in a 15-minute period - in either direction. To confirm what I am saying, have a look at the ATR of a 5 minute chart, or a 15 minute chart!
Scary indeed, unless this is going over your head.
The 14-period ATR of the 5-minute chart of EURUSD is currently 7 pips, and the 15 min ATR is 12 pips!! Currently volatility is low. It can get to 60 pips eaily - (see 5 and 15 min chart of EURUSD on 18th march 2009)
You would need to be exceptionally fast, alert, and have a good Internet connection/software etc to even begin to have a chance to close out a position as it moves into profit or indeed, into loss.
I don’t know anyone who could do that.
Now - let’s look at another extreme - leverage of 10:1 at the other end of the scale. In fact - I think you would find it very difficult to find a broker who would offer you 10:1 in Retail Forex.
I don’t know of any.
It is NOT in THEIR best interests to keep your account in YOUR hands … and growing.
Using the same scenario as above, with 10:1 leverage controlling 100,000 units of the base currency of the pair, you will need to submit $10,000 margin deposit. The big difference - and it is really huge - is that your pip value is only $1.
Now before you think: “Oh, I’ll never make any money at $1/pip” you could well be right … partly. But considering what your record is now, the news can only get better.
Currency trading is a big boy’s game - but since the regulations have opened it up to Retail Trading (or Off-Exchange Trading) it has been a licence to print money for any broker fortunate enough to have gotten established in those days (1996).
Brokers already knew that if they allowed traders the use of high leverage facilities, they would sweep clean any and all accounts, bar the savvy few who refused to indulge in this foolishness.
So why does the use of low leverage offer ANY advantage at all, given that traders can not make as much money as they could using the higher leverage freely offered?
As mentioned, FX trading is a game for big players with deep pockets. Foolishly, Joe Schmoe thinks he can match these bigger players, by artificially boosting his control of a contract, through use of leverage. Trading firms love to promote trading competitions, where their winners have managed to “turn $10,000 into $362,873.55 in only 90 days!”.
What they do not tell you is that the winners went for an all-or-nothing gamble, and it happened to pay off. They will NOT publish all results and ALL trades for the same reasons - it exposes the lies and untruths associated with the promotion of their “system”.
So, unfortunately, if you have been losing using 100:1 margin, going to 200:1 or 400:1 will only make things worse.
While 10:1 or 20:1 or 50:1 leverage may be slower, it is also streets ahead in safety. And the reason is this: You can place a 200-pip stop-loss order for $200 using 10:1 leverage! But if you are using a 100:1 leveraged account, the same 200-pip SL would cost you $2000. Not many people could afford that - especially if trying to operate on 2% risk of capital per trade.
So many switch to Mini accounts, or opt to put up with the dangers of higher leverage.
There is no quick way to riches in Retail Forex - no matter WHAT the advertisement says. In order to make money in this, you have to have money to begin with. However, the method I am showing readers, is a way out of the dilemma.
I am very sure of it.
Using a good Daily Charts method - such as I think we have in this thread, it is possible to make very good money, but not become wealthy … at least in the early part of your trading.
But if you are patient and disciplined and have a track record of growing your account, what’s wrong with adding any spare cash to your account and compounding returns that way? getting rich slowly is good too.
I have started a thread on another forum discussiong another LT trading method. If you Google " t2w Getting a Life … Position Trading the higher Time Frame " there is quite a bit to see with a different strategy.
Meanwhile, I have noticed many questions on the way through this thread, and want to answer as many as I can before wrapping it all up.
I also want to summarise the entire approach so as to make the method accessible to people who come in late - it is a tedious task to read through the whole thread.
Below I attach a current screen shot of the account balance of my open trades since 2nd April 2009 - in Demo only!!
And a screen shot taken a little later of the pips made. bear in mind the pip value is 10 times higher than reality because my Demo account is a Mini contract account.