This is a question for the mathematically gifted.
I am basing my risk on my account size and my stoploss then does it really matter how much leverage i have? (to break it down i trade on $48k and 1% of that is $480 as far as i can figure $480 at 1:1 or 1:400 is still $480). Currently I trade at 1:10 leverage I find when I trade on a 5 min chart I run out of free margin… which stops me from being able to Hedge. Can someone confirm or deny this kind of thinking?
Cheers
We can get as deep into the math as you would like — but, to answer your question, we don’t have to resort to math, at all.
• Using the numbers in your example, your risk will be the same regardless of the [I]maximum allowable leverage[/I] (broker leverage) applicable to your account. As you correctly pointed out, $480 at risk is $480 at risk, whether your account allows 1:1, 10:1, or 400:1 leverage.
• Furthermore, when your risk is based on (1) your account balance, (2) your risk percentage, and (3) your stop-loss, the amount you have at risk is not related to [I]the amount of leverage you are actually using.[/I]
(I’m assuming that you are perfectly clear on the distinction between maximum allowable leverage, and the leverage you actually use in a particular trade.)
Referring again to your example, with a $48k balance, and 1% risk percentage, your amount at risk will be $480, regardless of the size of your stop-loss.
Given those parameters, the size of your stop-loss will determine your position size. And your position size divided by your account balance will represent the leverage you are actually using. With a very close stop-loss (say, 10 pips), you will be using much more actual leverage than with a very wide stop (say, 100 pips). You can crunch the numbers for yourself, if you want to prove that statement.
• Returning to [I]maximum allowable leverage,[/I] in my opinion, the higher the better — because higher maximum allowable leverage corresponds to lower required margin (at almost all brokers *).
Required margin is a portion of your money put out of your reach, and unavailable for your use, for the duration of your trade. As you have noted, a large required margin amount can interfere with your trading. The remedy for that is higher maximum allowable leverage.
If you can get 100:1, or 500:1, or 1000:1 maximum allowable leverage, go for it. There is no harm involved in having very high maximum allowable leverage, so long as you control your risk in the way you described in your example.
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Clint has tackled the margin/leverage question, so let me take on this last bit. I’ll do it by way of asking a question. If, as I suspect, you are using the term “hedge” to mean holding a directly opposing position to the one you originally put on (e.g. long EUR/USD against a short EUR/USD trade), why?
You bring up math. If you run the figures you’ll notice that Long + Short = Zero Position. In other words, you wouldn’t run out of margin if you closed out your trade rather than hedging it and you’d accomplish the exact same thing in the end.
Firstly. Thanks for the clarification Clint.
rhodytrader - I suppose when I think about it. It’s not so much hedging as diversifying. The way I trade gets better results over the longer term when I have more than one trade open at any time… all things considered.
That’s a great idea. Figure out other financial instruments as well for hedging or diversifying. For instance Futures, Options which I am doing now but only on indices.
Clint, This is great. Confirms my thoughts that if my risk determines my stop, which determines my position size, broker leverage shouldn’t - doesn’t - impact what’s at risk as long as I stick to the process above.
Had this all in my head but you explained it with greater clarity and conciseness. I believe there is a tremendous amount of confusion about this among newer traders like myself.
Thanks for the post,
FR&L
Thanks for the kind words. I’m glad my post was helpful.
@Clint, excellent reply, I think a bit confusing for this rookie, are you saying that the size of your stop loss is not your per trade risk? and that is you have a wider SL you have less risk?
No, not exactly.
First, you choose an appropriate risk percentage, which determines the dollar-amount of your risk. In the previous example, the risk percentage is 1%, which corresponds to a risk amount of $480. This risk percentage is chosen without regard to where you will place your stop-loss.
Then you choose your entry price and your stop-loss. Your stop-loss is chosen without regard to the risk percentage which pertains to this trade. Let’s say your chosen stop-loss is 50 pips away from your entry price.
Finally, you set your stop-loss (in pips) equal to your risk amount (in dollars). In this case, 50 pips = $480. Therefore, in this trade, one pip (of profit or loss) is worth $9.60 (that is, $480 / 50 = $9.60). This pip-value will determine the position size of this trade.
Suppose you had chosen a stop-loss of 30 pips, instead. Then, one pip would be worth $16, and a different position size would be calculated.
In other words, the stop-loss you select will represent your risk, because you have equated it to your selected risk amount.
No, again.
In the example above, you have the same risk regardless of the stop-loss you subsequently choose. But, once you have specified your account currency, your account balance, the pair you want to trade, your chosen risk percentage, and your stop-loss – then you cannot also choose your position size. Instead, math will determine your position size, based on the other metrics you have chosen.
We could use the metrics in the example above to calculate the position size, by hand – but, let’s be lazy and use the Position Size Calculator, instead.
Let’s assume that the pair being traded is EUR/USD. We enter the following metrics into the Calculator:
The result looks like this –
If your trading platform allows you to trade in micro-lot increments, then you can enter a 96-micro-lot position. If your platform allows trades in mini-lots, then you can enter a 9-mini-lot position without exceeding your predetermined risk. Etc.
As you will see, when you enter a different stop-loss in the Position Size Calculator, the risk amount does not change, but the position size does.
One final note: We didn’t have to enter the current price for the pair being traded (in this example), because the quote currency in the pair traded matched the account currency (both USD).
But, in any calculation in which the quote currency does not match the account currency, the Position Size Calculator will ask for the current price of the pair being traded. Change the pair to USD/JPY, for example, and see how this works.
@krugman25 Thanks for the ultras quick reply!
@Clint got it, played around a bit, confusion cleared up thanks for the posts.
I’m starting to use this on my demo trades to make it an integral part of my process.
High leverage enhances the risk and traders usually tempts to take large positions. so as per my opinion it is a wise decision to avoid high leverage till the time you gain enough experience.
There are several ways to comfortably hege off high leverage and reduce the risk associated with same. Thats said high leverage is almost never necessary.
For example one method is building a profit hedge before scaling in and then laddering as the trade goes you way. Thus your always in profit and only risking profits not your equity.
As Clint has explained mathematically way back at the start of this thread. High leverage never increases risk if used properly. There are two differences between leverage and no leverage 1. the amount the broker makes off your trades. ie. if you have 400 to 1 leverage the broker makes 400 times the spread compared to if you trade 1 to 1 where the broker only makes 1x the spread. 2. With high leverage you are given the ability to enter the market at 400x less capital than if you weren’t using leverage.
Just wanted to stop by and say I was looking for this exact thing because I use a lot of leverage on small timeframes, and so many are saying how bad this is. (I couldn’t figure why because my stop loss would kick in at 1% risk which is long before equity falls below margin used (which is when you get liquidated?))
Thanks!
Clint, I do not understand this part of your analogy.
To keep things very simple let’s use a $1,000 account at 50:1 leverage.
Trading the EURUSD for a $1.00 parity.
I do not want to risk more than 1% of my equity or $10.00
If I set my stop at 10 pips that would be a risk of $10.00.
But if I set my stop at 20 pips then I am risking 2% or $20.00.
This is the part I am not understanding with relationship to my simple example.
This is quite simple
Clint is referring to maintaining your fixed 1% risk, regardless of the stop size (in pips).
Hence, a shorter stop at the same 1% risk would use more actual leverage than the same 1% risk on a wider stop, understand?
It doesn’t matter how big your stop loss is in pips - it will always be equal to your total chosen risk, aka 1% in Clits example.
