Hi, everyone.
I have just started learning FX and it looks interesting and fun. So i have question about leverage. Question is, is 10:1 leverage too high and reckless from risk management perspective? Or,is it ok to use that kind of leverage?
Thank you
Hi Government,
All trading strategies suffer occasional losses, technically known as drawdowns. The drawdowns may last a few minutes or a few years. To profit from your quantitative trading theory, it is essential to manage your risks in a way that limits your drawdowns to a tolerable level and yet be positioned to use optimal leverage of your equity to achieve maximum possible growth of your wealth. Furthermore, if you have more than one strategy, you will also need to find a way to optimally allocate capital among them so as to maximize overall risk-adjusted return.
In short, you need a benchmark to use when considering leverage. For example, some people may use 1:10 leverage and be comfortable in doing so, while other people may use 1:50 and also be happy in doing so. The big answer to your question is finding a tolerable loss rate, and then adjusting leverage around this to maximize your return.
Kind Regards,
James
For reasons which you will understand later in your forex education, the relationship between (1) the actual leverage used and (2) the actual risk being taken depends on how deep your stop-loss is.
For a scalper, whose risk per trade might be on the order of 5 to 10 pips, using 10:1 leverage (or even more) may be prudent. For a day-trader, whose risk per trade might be 25 to 50 pips, 10:1 leverage represents 5 times as much risk as the scalper is taking.
My advice to you, as a newbie, is this:
First, do not start out as a scalper. Learn to trade longer term than that.
Second, thoroughly learn the difference between (1) the maximum allowable leverage that a broker offers you, and (2) the actual leverage that you use in any given trade. If you don’t know what I’m talking about, study the lessons on leverage in the Babypips school, and search this forum for facts and insight on the sensible use of leverage.
When you have become competent in the use of leverage, then it will be to your advantage to deal with a broker who offers you the highest allowable leverage.
[B]Being allowed to use extremely high leverage does not obligate you to do so. [/B]
The advantage of high allowable leverage is that it corresponds to low margin requirements.
As an example, if your broker allows you 50:1 leverage, he is requiring 2% margin on each trade. If he allows you 100:1 leverage, then he is requiring only 1% margin on each trade. And, if he allows you 400:1 leverage, then he is requiring only 0.25% (one-quarter of 1%) margin on each trade. If you don’t understand this math, don’t worry. It will become clear to you as you study the related subjects of leverage and margin.
As a rule of thumb: the size of your stop-loss and the percentage of your account which you are willing to risk on a trade determine your position size. And the ratio of your position size to your account size determines how much leverage you are actually using. Therefore, if you choose your stop-loss and your maximum allowable trade risk prudently, then actual leverage used will take care of itself.