I’m planning on going live in a couple of months and would like to know how everyone approached leverage when they first started?
I appreciate it will vary depending on how the trade and macro environment are shaping up so rough answers will be enough to give me some clarity.
My aim is to steadily increase equity over the long term, similar to how a hedge fund approaches profit. I mention this to avoid the ‘use 500:1 leverage’ comments.
Thanks
Less is more. If you find yourself getting caught up in the thought of 'if this trade goes well, I’ll be making XX.XX!!!" then it’s time to step back and re-evaluate. The thought should be more along the lines of 'if this trade doesn’t go well, I’ll be losing XX.XX".
You can see how over-cranking your leverage will make that first scenario wayyyy more enticing, but will also make the second scenario wayyyy more defeating.
There are no hard-and-fast rules, but if you’re trading intraday (and so might trade anywhere from 5-20 trades per week), it’s prudent to keep your risk at 0.50% of your account balance or even less than that. It seems puny, but if you risk the commonly-touted ‘1% per trade!’… you could easily be out 5-20% in a single week (and to be fair, even using 0.50% per trade could put you out 2.5-10% in a single week…so you can see how going even smaller than that is intelligently conservative).
Losing the mentioned 5-20% will quickly escalate into blowing up the whole account because once that happens, your emotions will kick in and you’ll start revenge trading all over the place to try and compensate, only furthering your losses.
A sensible leverage is 1:250 or 1:500 of course without leverage, where is the fun in Forex. In fact one of the ways banks determine their performance is their gains derived from leverage, which is why they held very little Capital reserves pre-2008 and were quite happy to leverage debt to increase shareholder equity. So leverage is good to a point. I personally have 1:500 leverage.
I use MT4 so risk for me is not managed by margin trading rather via stop loss. Despite opening a trade with a specific margin my trades don’t close automatically if price blows through my margin, my entire account is exposed, so I need stop losses. So leverage ratio is not that key to me. Think more risk/reward ratio…
Hello [I]Corriston,[/I] and welcome to this forum.
So far, this thread has failed to address the most important points regarding leverage:
B The term “leverage” has two different meanings, and in any discussion you need to be clear about which type of leverage you are referring to.
B[/B] The “leverage” your broker offers (and advertises) is the maximum amount of leverage he will allow you to use. That’s why I refer to it as MAXIMUM ALLOWABLE LEVERAGE.
In almost all cases, brokers calculate MARGIN this way:
Required margin = 1 ÷ maximum allowable leverage.
If you play around with that formula, you will realize that [I]higher[/I] maximum allowable leverage corresponds to [I]lower[/I] required margin. And lower required margin is a good thing. So, as a general rule, you are better off with high maximum allowable leverage.
Don’t shy away from accepting 500:1 (or even 1000:1) maximum allowable leverage from your broker. Just because he allows you to use outrageous amounts of leverage — that doesn’t mean you must, or should, use those amounts of leverage. But, regardless of how much leverage you actually use, you will benefit from [I]higher[/I] maximum allowable leverage, because on every position which you take, your broker will set aside a [I]smaller[/I] portion of your account as required margin.
If your broker offers 500:1 maximum allowable leverage, then he will require only 1/5 of 1% of the notional value of your position as required margin — according to the formula,
Required margin = 1 ÷ maximum allowable leverage = 1 ÷ 500 = 0.002 = 1/5 of 1%.
Let’s say you take a position with a notional amount of one standard lot (100,000 units of currency), and let’s say that your position has a notional [I]value[/I] of $100,000. Your broker will require (set aside) margin of $200. This amount will be out of your reach, and unavailable for you to use or withdraw, for the duration of your trade.
If, on the other hand, your broker offers maximum allowable leverage of only 50:1 (which happens to be the maximum amount legally available in the U.S.), then the margin required on your 1-lot position will be $2,000 (instead of $200). That difference may be significant to you, depending on the size of your account, the way you trade, and your money management rules.
B[/B] Which brings us to the second “type” of leverage — the amount of leverage you actually use. You control this leverage, yourself. If you take positions which are too large for the size your account, then your ACTUAL LEVERAGE USED will be inappropriately large. On the other hand, if you trade prudently, your actual leverage used will be small — probably extremely small compared to the maximum allowable leverage offered by your broker.
The formula for calculating the actual leverage used in any trade is:
Actual leverage used = position size ÷ account size.
If you have a $20,000 account balance, and you take the 1-lot position described above, then
Your actual leverage used = $100,000 ÷ $20,000 = 5 (meaning 5:1 actual leverage used).
Most small retail traders (like ourselves) use actual leverage ranging from 5:1 to 10:1 (based on [I]all[/I] positions open at any one time). Some very conservative traders typically use less than 5:1 actual leverage. At the other end of the spectrum, some forex portfolio traders use actual leverage approaching 30:1 — but, the risks associated with portfolio trading are different from the risks associated with other trading methodologies, so portfolio trading involves money management rules which are very different from other styles of trading.
As previous replies to your question have indicated, controlling your risk on every trade, and controlling your overall risk when you have multiple open trades, automatically limits the actual leverage you are using, so that generally you don’t even have to think about the amount of leverage you are actually using, and you almost never have to use the formula given above.
Only offshore brokers can offer you leverage 500:1 to 2000:1. This is one of the benefits of these brokers. Do not think that leverage is bad for forex, it is a very good way to get high returns on your investment. You just have to know how and when to use high leverage.
In the end leverage does not matter as much as risk management. No matter what leverage you will use your total loss should remain the same. For example if you have a $10,000 account and you pick a 3% per trade risk profile, this means you may lose $300 on the trade which does not change. No matter if you use 1:1 or 1:1000, your total loss should not exceed $300.
Leverage like a double edged sword. And the matter is not how big leverage we use for trading, but how can we maximize leverage which we use for trading. Trading with1:500 is also not a problem. We must use leverage which is according with our strategy.
[QUOTE=“Clint;591358”] Hello Corriston, and welcome to this forum. So far, this thread has failed to address the most important points regarding leverage: (1) The term “leverage” has two different meanings, and in any discussion you need to be clear about which type of leverage you are referring to. (2) The “leverage” your broker offers (and advertises) is the maximum amount of leverage he will allow you to use. That’s why I refer to it as MAXIMUM ALLOWABLE LEVERAGE. In almost all cases, brokers calculate MARGIN this way: Required margin = 1 ÷ maximum allowable leverage. If you play around with that formula, you will realize that higher maximum allowable leverage corresponds to lower required margin. And lower required margin is a good thing. So, as a general rule, you are better off with high maximum allowable leverage. Don’t shy away from accepting 500:1 (or even 1000:1) maximum allowable leverage from your broker. Just because he allows you to use outrageous amounts of leverage — that doesn’t mean you must, or should, use those amounts of leverage. But, regardless of how much leverage you actually use, you will benefit from higher maximum allowable leverage, because on every position which you take, your broker will set aside a smaller portion of your account as required margin. If your broker offers 500:1 maximum allowable leverage, then he will require only 1/5 of 1% of the notional value of your position as required margin — according to the formula, Required margin = 1 ÷ maximum allowable leverage = 1 ÷ 500 = 0.002 = 1/5 of 1%. Let’s say you take a position with a notional amount of one standard lot (100,000 units of currency), and let’s say that your position has a notional value of $100,000. Your broker will require (set aside) margin of $200. This amount will be out of your reach, and unavailable for you to use or withdraw, for the duration of your trade. If, on the other hand, your broker offers maximum allowable leverage of only 50:1 (which happens to be the maximum amount legally available in the U.S.), then the margin required on your 1-lot position will be $2,000 (instead of $200). That difference may be significant to you, depending on the size of your account, the way you trade, and your money management rules. (3) Which brings us to the second “type” of leverage — the amount of leverage you actually use. You control this leverage, yourself. If you take positions which are too large for the size your account, then your ACTUAL LEVERAGE USED will be inappropriately large. On the other hand, if you trade prudently, your actual leverage used will be small — probably extremely small compared to the maximum allowable leverage offered by your broker. The formula for calculating the actual leverage used in any trade is: Actual leverage used = position size ÷ account size. If you have a $20,000 account balance, and you take the 1-lot position described above, then Your actual leverage used = $100,000 ÷ $20,000 = 5 (meaning 5:1 actual leverage used). Most small retail traders (like ourselves) use actual leverage ranging from 5:1 to 10:1 (based on all positions open at any one time). Some very conservative traders typically use less than 5:1 actual leverage. At the other end of the spectrum, some forex portfolio traders use actual leverage approaching 30:1 — but, the risks associated with portfolio trading are different from the risks associated with other trading methodologies, so portfolio trading involves money management rules which are very different from other styles of trading. As previous replies to your question have indicated, controlling your risk on every trade, and controlling your overall risk when you have multiple open trades, automatically limits the actual leverage you are using, so that generally you don’t even have to think about the amount of leverage you are actually using, and you almost never have to use the formula given above.[/QUOTE]
Really helpful thanks.
This question may sound vague but how do I know how much leverage I am using in a trade?
I’m currently using a 5000 account and have only been taking 0.10 position sizes as I want to keep my demo days as realistic as possible.
When opening the demo account on metatrader 4 I set the leverage at 100:1.
Thanks
Assuming you’re trading a pair where USD is the cross, XXX/USD
0.10 is 10,000 units, or a notional value of $10,000
Your balance is $5,000
So, $10,000 / $5,000 = 2
On this trade you’re using 2:1 Leverage.
Actually, a 0.10 lot position will have a notional value of $10,000 [I][B]if USD is the base[/B][/I] currency in the pair being traded — that is, if the pair is of the form USD/XXX. (The only exception to this would be a situation in which XXX/USD is the pair being traded, and XXX is at exact parity with USD — that is, XXX/USD = 1.0000 — a very rare situation.)
The rest of your answer is correct, based on a trade with a notional value of $10,000 and account balance of $5,000.