Hi guys. I’ve been playing around with the leverage settings with my broker and found that smaller leverages like 1:50 or 1:100 will eat up more margin on a single trade with the same lot size compared to a leverage like 1:888. Meaning with a higher leverage, less margin is taken and therefore more trades can be placed. Is that ideology correct?
Hi @JoshRSA,
You have understood part of what you should know about leverage, but you are still missing some important details.
What you have understood correctly is that the more leverage your broker makes available to you, the less money you have to put up as margin to maintain your trading positions. In fact, your maximum leverage and your minimum margin requirement are inversely proportional. As your maximum leverage goes higher, your minimum margin requirement goes lower. A 50:1 maximum leverage is the same as a 2% minimum margin requirement. A 100:1 maximum leverage is the same as a 1% margin requirement and so on.
However, the important detail you are still missing is that when it comes to leverage it’s necessary to understand the difference between the maximum leverage available to you, and the actual amount of leverage you are using. Maximum leverage is like the top speed your car can reach, while your effective leverage is like the speed you actually drive your car. And just as you would never drive your car at its top speed, you should never look to open trading positions so large that your effective leverage reaches the maximum leverage available to you.
That’s because leverage magnifies both your gains and your losses. Beginner traders tend to think only about how much money they can make and don’t pay enough attention to how much they could lose. You may find this article helpful in understanding the rationale behind risking only 1% of your account balance per trade: The Most Important Math in Trading | New Trader U
It would be very hard to limit your risk to 1% of your account balance if you are using more than 10:1 effective leverage. That’s why studies have shown that traders who use 10:1 leverage or less tend to perform better than traders who use more than 10:1 leverage.
Regardless of the maximum leverage available to you through your broker (50:1, 100:1 or 888:1, and you should be concerned about any broker offering this much leverage to clients), you can choose to use 10:1 effective leverage (just as you can choose to drive 45 mph, whether your car has a top speed of 155 mph or 255 mph) which would equate to one micro lot (or 1000 currency units risking 10 cents per pip) for every $100 in your account balance.
2 Likes