Leverage Question, argg

Beginner Questions
1

Argg,

I have read the leverage & margin section 10 times, I have searched online… I just don’t get something about it.

Lets say Person A buys GBP/USD for x.xxxx. He’s 100:1 (1% margin).
He has 10,000… His margin is 1% of (100,000) 1 standard lot = $1,000.

I get that, he has 9,000 usable meaning he can survive a market swing of (900 pips at $10.00 per pip)… right??

NOW, Person B says, I want to be safe Buys GBP/USD for x.xxxx. He’s 25:1 (4% margin).
He has 10,000… His margin is 4% of (100,000) 1 standard lot = $4,000.

He has 6,000 usable meaning he can ONLY survive a swing of 600 pips before he has to back out. Is he being safe because he’s protecting more money?

I would think he would want as much money in his account to withlast the largest swing he needs. Lets say he holds a position for a week. He may need to withstand a 1000 pip swing.

Am I thinking about this right?? Lower Leverage only means more money saved, but doesn’t reduce risk.

Thanks
Jeff.

2

Hi Jeff,
You seem to be correct about leverage. What really matters is not your account leverage but your true leverage. Your true leverage is decided with your money management rules. In the BabyPips school the author goes into greater detail on account leverage vs. true leverage.

3

OK,

So I’m not going insane. Then isn’t True Leverage just number of lots (along with your position size (micro vs mini vs standard).

So, if you had:

Person A has 10k in his account
He buys 5 lots as a mini (5*10,000) at 100:1 (1%)

Then his “True” margin would be 500? So if you had 10k, you’re position could sway only 1980 pips at 5$. Is this correct?

Person B has 10k in his account
He buys 5 lots as a mini (5*10,000) at 25:1 (4%)

Then his “True” margin would be 2,000?? So if you had 10k, you’re position could sway only 1600 pips at 5$.

Is this right also?

Thanks
Jeff.

4

Hi Jeff,
Disregard account leverage for the moment. That only applies to what your broker is going to want you to margin to hold a position.

Two examples of true leverage would be:

  1. 100:1 $1000 balance holding a full lot $100,000
  2. 10:1 $10,000 balance holding a full lot $100,000

Most basic example I can give.

Now if your account leverage was 100:1, the first example would be hard to hold considering that the broker would want you whole balance as margin. That doesn’t even factor in the spread.

5

First, I need to point out an error here. Margin is based on the VALUE of the position, not the SIZE. If GBP/USD is at 1.97, then a standard lot of GBP/USD has a value of $197,000. That means 1% margin is $1970.

Am I thinking about this right?? Lower Leverage only means more money saved, but doesn’t reduce risk.

YES!!!

Well, I wouldn’t put it “money saved” since it’s not like an expense, but I think you get the ideal Allowable leverage is not the determinant of risk. Only position size relative to your account (gearing or actual leverage or whatever) determines risk.

6

When the dust settles…

I. Both were shooting for $1,000 bucks for 100 pips.
Trader A. $10,000 account; $1,000 margin X 100 ratio = $100,000 Lot
$10.00 a pip X 100 pips = $1,000 (10% gain)
Trader B. $10,000 account; $4,000 margin X 25 ratio = $100,000 Lot
$ 10.00 a pip X 100 pips = $1,000 (10% gain)

II. Both were risking different amounts of their portfolios to get the same buck
Trader A. $10,000 account - $1,000 margin = $9,000 useable (90% at risk), 900 pip margin call
Trader B. $10,000 account - $4,000 margin = $6,000 useable (60% at risk), 600 pip margin call

III Both were at 10:1 “True” Leverage
$100,000 lot , $10,000 account

Some would say Trader B. is the better trader, he is risking less of his portfolio to get the same buck return, at the same pip movement as Trader A. 100 pips will make them $1,000 bucks

Trader B. better be a good chart reader. He only has a 600 pip swing room for error. While Trader A is aware he is isn’t that great of a chart reader and allowing more room for the trade to go his way with an extra 300 pips to get at 900 pips, but is in total understandment that is he is risking more damage to his portfolio to accomplish this.

There is no correct answer which is better… imo
Depends on the trader and his abilities. ;o)

Added this just to show 500 ratio, pretty retarded imo ;o)
Trader C. $10,000 account; $200 margin X 500 ratio = $100,000 Lot
$ 10.00 a pip X 100 pips = $1,000 (10% gain)
Trader C. $10,000 account - $200 margin = $9,800 useable (98% at risk), 980 pip margin call
10:1 “True” Leverage

The jump from 100 ratio to 500 ratio is insane, your risking basically the entire portfolio for not that more room for error. Looking at an extra 80 pips to get at 980…

all three examples make $1,000 (10%) for 100 pips…

7

I like the answers here.

But they are theoretical.

With my school teacher skills I am going to design a diagram that visually shows what is going on in all the aspects of a forex trade.
This diagram will be a teaching aid type picture, taken from another field of human endevour to try to clarify the situation so that even newbies can quickly see the answers.

A picture can say a thousand words - and give much understanding.

Having said that, I know that I have my work cut out designing such a picture example.

Immediate tips to get started would be appreciated.

8

You have your work cut out for you. If anyone is capable of accomplishing such a job it would be you. You seem to have your stuff together. For tips, I personally like cute animals and cartoon characters:D

I would like to ad one more thing about leverage. If anyone is to worried about how much leverage there broker will give them, they are already doomed. Just thinking about putting on a trade large enough to worry about a margin call is a disaster.

9

Personally, i dont think leverage is an issue 1:1 or 1:500 or somewhere in between. A pip is a pip, be it a buck a pip or $10.

Your money management is where you determine your risk so provided you have good MM, what difference does Leverage make?

Thats my two cents, bear in mind i’m still learning this myself;)

Cheers