Hello Babypips!
As my title ask, What is the most common leverage for Daytraders in forex?
I want my question to reach out to those who trade for a living. Why? Because, I want to get an as accurate
answer, as possible.
I know what brokers offer in leverage, but I mean, is there people (here) using as high as 500:1 and 100:1?
Thanks in advance
Hello, John
It’s clear from your post that you understand the two types of leverage:
B[/B] maximum allowable leverage, offered by your broker, which is mathematically related to the margin required on each of your trades; maximum allowable leverage usually has advertised numbers like 100:1, 500:1, 1000:1, etc.
B[/B] the actual leverage you use in a particular trade, which is determined by you, and is not related to maximum allowable leverage EXCEPT that it cannot exceed maximum allowable leverage; actual leverage used by retail forex traders generally ranges from 1:1 to 20:1, depending on trading style and risk tolerance, among other factors.
High maximum allowable leverage is handy, because it is associated with low required margins. In most brokerage accounts, the relationship between maximum allowable leverage and required margin is usually a fixed mathematical relationship: Required margin = 1 ÷ Maximum allowable leverage (example: if maximum allowable leverage is 100:1, then required margin = 1 ÷ 100 = 1%). Generally, then, you should welcome high maximum allowable leverage.
It’s not only possible, but common and advisable, for traders to ignore the leverage they actually use, because proper position-sizing takes care of that leverage.
Example (based on a typical day-trading scenario, since that’s what you asked about): Let’s say you want to trade EUR/USD in a EUR-denominated account with a balance of €2500. You determine that your trade needs a 40 pip stop-loss. You want to risk NO MORE THAN 1.5% of your account balance on this trade.
Clearly, you want to determine the size of your position such that a loss of 40 pips will cost NO MORE THAN €37,50. You could figure this by hand, or you could use a Position Size Calculator to do it for you. Let’s say you use the Calculator and, using a EUR/USD price of 1.0800, you calculate that your position cannot be larger than 10125 units. If your brokerage account allows you to trade in unit-amounts, then you can trade the full 10125 units. If your account allows you to trade in micro-lots (increments of 1000 units), then you can trade only 10 micro-lots (10000 units), without exceeding your predetermined 1.5% risk limit.
Let’s say that you trade the full 10125 units (in an account such as Oanda, which allows trading in unit-amounts). You now have a position worth €10125 in an account with a balance of €2500. Obviously, you are using 4.05:1 actual leverage.
But, you didn’t have to calculate, or choose, this amount of leverage before configuring your trade: the position-size process took care of actual leverage — as it always does for all traders except super-aggressive scalpers, who may be using tiny (mental) stop-losses and huge trade sizes.
For day-traders and longer-term traders, ignoring actual leverage works just fine.
Notice that our typical example of a day-trade resulted in actual leverage at the very low end of the 1:1 - 20:1 range that I suggested as a ballpark number.
Given a certain size account, and given a certain level of risk tolerance (1.5% in our example), position size — and therefore leverage used — depends entirely on the size of the stop-loss you need. And, since larger stop-losses are [I]generally[/I] needed in longer-term trades, leverage used [I]generally[/I] becomes a function of trading style, as your question implied. But, you simply don’t have to worry about it.
Just to satisfy your curiosity, you could do a series of position-size calculations (assuming EUR/USD = 1.0800, as before) and then figure the corresponding leverage used for each position, for the following hypothetical scenarios:
• an aggressive scalper willing to risk 25% of account, with a 5-pip stop-loss
• a less aggressive scalper willing to risk 10% of account, with the same 5-pip stop-loss
• a day-trader willing to risk 3% of account, with a 25-pip stop-loss
• a day-trader willing to risk 2% of account, with a 50-pip stop-loss
• a swing trader willing to risk 1% of account, with a 100-pip stop-loss
• a position trader willing to risk 0.5% of account, with a 250-pip stop-loss
Welcome to this forum, by the way !
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A BIG PIPPIN THANK YOU, Mr.Clint! You made things very easy to understand here! And I will actually save this as a WORD document, really good source of information you deliver here!
But there is one thing that I messed up in my head, I think. As I quoted, you say “Forex traders generally ranges from 1:1 to 20:1, depending on trading style and risk tolerance, among other factors.” Then I ask myself, don’t daytraders need a lot of money in the start to actually gain profits you can live of, if they only use 1:1 - 1:20?
Maybe you made that point clear, but I clearly missed it if so:51:
Thanks by the way, I love this forum so far!
(Sorry for my bad english, Im swedish)
Short answer:
Yes, a day trader (or any other type of trader) who aspires to live off his trading profits needs a large bankroll to start. But, the actual leverage employed is not the controlling metric here. The metrics which, factored together, make a large initial bankroll necessary are the trader’s profit factor and his income requirements.
Long answer:
A trader who aspires to earn his living trading forex needs the following:
• Step 1 — first, he needs a reliable, consistent trading methodology, with a proven track-record of producing on average x-percent profit per month, month after month, in all sorts of market conditions.
• Step 2 — second, he needs to determine [I]realistically[/I] how much gross income he will have to withdraw from his trading account each month, in order to sustain his lifestyle [I]over the long term.[/I]
• Step 3 — third, he needs to calculate the initial account balance required to make Step 1 accomplish Step 2 — [I]then he needs to fund his trading account with twice that amount.[/I]
Let’s put some numbers on this.
Suppose you have a reliable, consistent trading methodology which you [I]yourself[/I] have used to generate profits averaging 2% per week, week after week, month after month. Two percent per week, compounded over 4.33 weeks per month, is 9% per month (rounded off).
Suppose you determine that you require €4000 in gross income per month (before taxes), in order to maintain your current lifestyle over the long term.
A simple calculation now tells you that 9% of €44445 equals €4000. So, if you bleed your €44445 account of all its profits every month, month after month, you will be able to live off your forex trading. [I]Until something unforeseen strikes the market, or your account.[/I]
In order to (1) protect yourself from the unforeseen, (2) provide for future inflation in the cost of living, and (3) grow your trading account (so that you are not bleeding it of all its profits) — you need to double that €44445 initial balance; let’s round it off to €90000 as a starting amount.
You can tweak these numbers to your heart’s content, but don’t fall into the trap of wishful thinking. Don’t pretend that your trading methodology can produce a higher percentage return on equity than it really can. And don’t pretend that you need less income than your lifestyle actually requires.
That being said, you can plug in the numbers that apply in your particular situation. Keeping the 2%-per-week metric constant for the moment, it’s clear that your income requirement and your required account balance are [I]proportional amounts.[/I] You can reduce (or increase) the income figure by x-percent, and this reduces (or increases) the required balance by the same x-percent.
Also, given a set amount of required monthly gross income, you can determine the effect of changing the profit factor in your account (2% per week, 9% per month, in the example above). The profit factor is [I]inversely proportional[/I] to the required balance. So, if you reduce the profit factor by a certain percentage, you automatically increase the required balance by the same percentage. Note that we are applying a percentage to a percentage, here. Example: if you reduce the 9%-per-month profit factor to 7% per month, you have reduced it by 22.22%. This requires your account balance to be increased by 22.22% to €110000 (rounded off). €90000 x 1.2222 = €110000.
Finally, the most tempting tweak is probably this: “I don’t need to double the required balance calculated in Step 3 (above). Increasing the calculated balance by, say 25%, should be good enough.” And maybe you’ll get by with that. However, [I]my suggestion[/I] is doubling it (a 100% increase). This increase in the calculated balance provides protection against a host of nasty events, and it provides a means for building wealth (which, presumably, your monthly income withdrawals cannot provide). So, in my view, if you cheat this particular provision of the plan (above), you are just cheating yourself.
It’s tragically naive to think that you can fund a forex trading account with €1000, or some other tiny amount, and — because you’ve discovered the Holy Grail of trading — you can start living off the profits from your tiny account. If you try that, and it works for a month or two, celebrate your good luck — because that’s all it is. Take some of your windfall profits out of your account, and take your wife or girlfriend out for a fancy dinner. Then, get serious, and properly fund a trading account that actually can make it possible for you to quit your job, and trade for a living.
How you manage to properly fund your account is another discussion, altogether. But, slowly and steadily building a tiny hobby account into serious money is one good way — if you have the profitable trading methodology, the required discipline and the required patience.
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Hi Clint
I have one additional question to this. Im still learning to understand relation between position size, leverage and margin, so my assumption might be totally wrong. But if I understand this correct you cant open 10125 units order with €2500 account, when you have your account set to leverage 1:1 (10125 units = €10125 as margin from your account). In order to open this trade you need to have leverage set on your account at least 1:5, where margin needed for this amount of units is approx. €2000. But no matter which leverage you have set on your account, you always risk only those €37,50 (assuming you always calculate position size for that risk). So higher leverage pretty much means, that with €2500 account you can open more trades with same risk. Is that correct?
Thanks Clint, another good answer!
Then my play would be to trade 5000 Euro into an real trading account for later on in life.
Thanks again!
Correct.
If you have done something silly, like limiting the leverage you can use to 1:1, then prepare yourself for some really boring trades.
Consider a 100-pip move in your favor in the EUR/USD. A 100-pip move in the EUR/USD changes the price of the EUR vs the USD by almost 1% (at current prices). Let’s say that your trading methodology captures half of this move — your system has earned you 50 pips. Any trader would consider 50 pips to be something worth going after.
But, you earned those 50 pips in an account in which your leverage is limited to 1:1. Run the numbers on a €1000 account, trading a €1000 position in EUR/USD in which you earn 50 pips, and you will see that [I]you are trading for peanuts.[/I]
I’ll save you the trouble, and run the numbers for you. If you traded this move, capturing a 50-pip profit, using 1:1 actual leverage in a €1000 account, you would earn — drumroll, please — a whopping €4,63. The EUR/USD moved almost 1%; you captured half of that move; and your reward was a measly 4 euro and 63 cents.
Do you see now why [I]leverage makes retail forex trading worth doing?[/I]
High maximum allowable leverage reduces the required margin on every trade, and makes it possible for you to trade position sizes larger than your account balance.
That 50-pip profit should have put [I]at least[/I] 4 times as much money (profit) into your account.
Limiting your available leverage to 5:1 is almost as silly as limiting it to 1:1.
And [I]€2000 margin[/I] on a €10000 position (one mini-lot) is [I]ridiculously high.[/I]
Consider using a trading platform in which maximum allowable leverage is 50:1 (if you’re trading with a U.S. broker), or [I]much more than 50:1[/I] (if you’re trading with a broker in a country where the government is not trying to destroy retail forex trading).
At 50:1 maximum allowable leverage, margin is 2% of position size — €200 on a €10000 position.
At 100:1 — margin is €100 on that position.
At 500:1 — margin is €20 on that position.
And so forth.
Nobody is suggesting that you use 50:1, or 100:1, or 500:1 actual leverage. Those figures are simply limits, and you shouldn’t come anywhere near approaching those limits.
Limit your risk on every trade to a prudent percentage of your account balance — say, 1% or 2%. Certainly, no more than 5%. Then use a Position Size Calculator to determine the size of your trade, based on your predetermined risk percentage, your account balance, and your predetermined stop-loss. And you will find that [I]the actual leverage you are using[/I] becomes a non-issue — it takes care of itself.
That is not correct.
In the example, risk percentage was chosen to be 1.5%. The risk in euro turned out to be €37,50 based on an account balance of €2,500 and a position size of €10125. This is possible ONLY IF your account allows you to trade with (roughly) 5:1 actual leverage, or more.
If your account limits you to 1:1 leverage, as your previous questions implied, then you can’t open a 10125-unit position, and the €37,50 risk amount will not apply to the position you are able to open.
Yes. You can trade larger positions, and/or you can trade multiple positions, without exceeding the maximum allowable leverage offered by your broker.
High maximum allowable leverage is not a license to be reckless. It allows you to trade meaningful position sizes, rather than wasting your time chasing nickels and dimes (or whatever the euro equivalent of nickels and dimes would be). And high maximum allowable leverage reduces the portion of your account which is tied up as required margin, [I]freeing more of your money for your use[/I] in opening and managing positions.
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Sounds like a plan.
Leverages is one helpful trading instrument which helps to increase or multiply your trading. With a leverage of 100:1for example you can hold a position size of $100,000 with just $1,000. This surely looks wonderful but new traders shouldn’t rush at leverages carelessly. While leverages may help you increase your trading size, it could also increases the chances of getting wiped out in your account in case of losses. Proper risk management suggest using moderate leverages like 3:1 as it gives your account more breathing space. Don’t forget to add your stop loss, it is a vital component of money management.
So what you are saying is. For example lets say I have 5 000$ on my account. Im willing to risk 1% per trade, which is equal to 1 mini lot (10 000 units) with 50 pips S/L. It doesnt matter what maximum leverage is set on my account, because my actual leverage is 1:2. Only difference between 1:50 or 1:100 account is amount of margin that will we used from my account? I will always risk only that 1%.
I was starting with 1:500 at Hotofrex when I was a newbie. After 4 years of trading I just lowered it to 1:400 as basically leverage plays small role in your trading. You can effectively manage risks tuning lot size for your trading strategy.
Cheers.
You’ve got it.
High maximum allowable leverage (or broker leverage, as it’s sometimes called) is a good thing. I’ve often said ‘The higher, the better’ — NOT because I care about leverage (I don’t), but because higher broker leverage means lower required margin.
You might be surprised to know that there is at least one broker who currently disconnects leverage from margin. YouTradeFX (a broker I am NOT recommending), limits allowable leverage to 500:1, but requires ZERO margin on retail spot forex trades in accounts up to $100K.
So, to be completely accurate, we have to say that [I]in most cases,[/I] higher broker leverage means lower required margin.
In one respect, maximum allowable leverage is like the credit limit on a credit card. The credit limit may be $50,000 — but, [I]the actual amount of credit you use[/I] is determined by you, not by the credit card issuer. For most traders, in most trading situations, using [I]all of the maximum allowable leverage[/I] offered by your broker would be about as reckless as using [I]all of the credit[/I] offered by your card-issuer.
Keep in mind that your example (above) is based on a trade in which the cross-currency of the pair you are trading matches your account currency. That is, the numbers in your example are correct if you are trading a pair of the form XXX/USD (such as EUR/USD) in your USD-denominated account.
If you trade a pair of the form XXX/YYY (such as GBP/JPY), or USD/YYY (such as USD/CAD) the Position Size Calculator will ask you for an additional price, and [I]the position size calculated will not be 10,000 units.[/I]
Congratulations on mastering the leverage concepts!
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