[quote=“soo13, post:1, topic:105208, full:true”]
- I also had a question about leverage, i understand that given a 1:100 leverage, we can control a standard lot with $1000 margin. And the risk with leverage is that any loss in pip is magnified by the lot size chosen. So if we were in a EUR/USD and we went long, we would lose $10 for every pip so after 10 pips our margin is canceled. This is my question: lets say the exchange rate lost 12 pips, can we go into debt or owe money at that point?[/quote]
@soo13
Make sure you understand the difference between the MAXIMUM ALLOWABLE LEVERAGE offered to you by your broker, and THE AMOUNT OF LEVERAGE YOU ACTUALLY USE IN A PARTICULAR TRADE.
Your broker might offer 100:1, or 500:1, or 1000:1 MAXIMUM ALLOWABLE LEVERAGE, but that does not determine the amount of leverage you actually use. And, clearly, ACTUALLY USING huge amounts of leverage is a recipe for disaster in most trading situations.
As your question implies, using enormous leverage can result in a margin-call, which can wipe out a large portion of your account.
Most brokers will close your over-leveraged position with a margin-call BEFORE your account reaches zero equity. And, therefore, you will not (in most cases) go negative, and end up owing your broker money.
However, extreme market conditions (such as the “Black Swan” event of January 2015) can undo the best broker policies, so it’s possible in such cases to get your positions closed far below the normal trigger-points for margin-calls. And, in these rare cases, your account could show a negative balance.
Some brokers offer negative-balance protection, meaning that any negative balance in your account caused by disorderly market conditions will be covered by the broker. Check with your own broker to find out what his policy is, regarding negative balances.
Returning to the leverage question:
If you pre-determine your maximum allowable RISK (say, 1% or 2% of your account balance), and use that figure to determine the appropriate position size for every trade you enter, then the actual leverage you use will take care of itself, and you need not even calculate it.
So, what’s the point of high MAXIMUM ALLOWABLE LEVERAGE ?
Well, it’s inversely related to REQUIRED MARGIN. That is, high maximum allowable leverage corresponds to low required margin. And, in every case, low required margin is a good thing — it’s less of your money which is set aside (out of your control) at the start of your trade.
But, it’s entirely possible to have high maximum allowable leverage (say, 100:1) and use low actual leverage (say 10:1, or 5:1, or less).
Whenever you hear someone talk about leverage, make sure you know which type of leverage is being referred to.
[quote=“soo13, post:1, topic:105208, full:true”]
- I understand how money is made when you go long~ buy a lot, wait for it to go up in value and sell it/close the trade. But how is it possible to make money when you start a new trade and decide to go short, as in how do you sell what you haven’t bought?[/quote]
Forget the idea of “buying” and “selling” currencies in the retail forex market. It does not happen.
There is NO buying or selling of individual currencies, or of currency pairs, in this market. In fact, the whole idea of “buying” a currency pair is ridiculous. If you actually bought one, what would you own ?
In the retail forex market, we speculate on price moves.
Speculating is very similar to gambling — some would say that it is identical to gambling. Basically, you place a bet with your retail forex broker on the future direction that a particular price will go. You can bet that it will rise (meaning you go LONG), or you can bet that it will fall (meaning that you go SHORT). In each case, the mechanics of the trade are the same: you place a bet of a particular size (your position size) and a particular direction (up = LONG, or down = SHORT). And you earn a profit, if you bet the right way; or you suffer a loss, if you bet the wrong way.
If the gambling analogy bothers you, I’m sorry. It is what it is.
Every new trader asks the question you asked: How can you sell something you don’t own? When I was learning to trade commodity futures, the answer I was given was:
He who sells what isn't his'n, must buy it back or go to prison.
That little ditty describes (sort of) short-selling in the futures markets. But, it has nothing to do with short-selling in the retail forex market.