This is going to be the dumbest question on here most probably but rather ask a dumb question then getting myself into a bit of a hick up later.
I am going through the whole babypips.com school lol , i know right, and am slowly progressing through it (wish i could get a certificate after though) and I have gone through and learnt what margin and leverage etc is now…
I have decided to start small on a live account, but i get a drop down menu and asking what type of leverage i want…1;1000, 1;800, 1;700, 1;600, 1;500, 1;300, 1;100, 1;50…
So which one would be best to go for though…
I do apologize for the silly question everyone and I would even go back to school if need be…but i thought who better to ask then the people on here…
hey…
Thanks for the question.
For a newbie in forex, you should make sure that your leverage never exceeds 1:100…so ideally
stick to 1:50 if you have that choice. You will make less but it will cushion you from big losses that accompany
huge leverage.
That drop-down is asking you [B]what limit do you want your broker to place on you?[/B]
The correct answer would be [B]no limit, at all.[/B] But, obviously, that’s not one of the choices offered to you.
[B]So, choose 1000:1 maximum allowable leverage,[/B] because that will make required margin negligible for you. Then, use self-discipline and common sense, and never use more than 10:1 [B]actual leverage[/B] in any of your trades.
Let’s walk through a scenario. Let’s say you specify 1000:1 leverage in response to the drop-down menu. This means that your broker will allow you to use this ridiculously high degree of leverage. (But, of course, you’re smarter than that.)
1000:1 leverage also means that, on every one of your trades, the margin required by your broker will be only 1/10 of 1%. In other words, for a position size of 1 micro-lot (1,000 units of base currency), margin will be only 1 unit of that currency. For a position size of 1 mini-lot (10,000 units of base currency) margin will be only 10 units of that currency. And for a position size of 1 standard lot (100,000 units of base currency), margin will be only 100 units of that currency.
If you were to choose 50:1 maximum allowable leverage (instead of 1000:1), the margin required on every trade would be 2% (instead of 1/10 of 1%) — that is, it would be 20 times as much.
Margin is simply a portion of your money set aside by your broker, which you can’t access for any purpose until after your trade is closed. Why would you want this sum of money to be any higher than it absolutely has to be?
Okay, you have 1000:1 maximum allowable leverage, [B]but you’re only going to use a reasonable amount of leverage[/B] — say 10:1, or less. And here’s the cool part: you don’t even have to figure your leverage on a trade-by-trade basis. Instead, you’re going to limit your risk on every trade to no more than 2% of your account, and presto, actual leverage will take care of itself.
Let’s walk through it. Let’s say you have a $500 account, and you have 1000:1 maximum allowable leverage. You decide to take a position in EUR/USD, and you intend to limit your risk on this trade to no more than 2% of your account.
Because your maximum allowable leverage is so high, you don’t have to worry about how much of your account is tied up in margin. So, basically, your entire $500 is available to support your trade. But, you aren’t going to risk $500. You’re going to risk no more than $10, which is 2% of $500.
Let’s say that your analysis of the EUR/USD trade indicates that you need to allow a 40-pip stop-loss on your trade. In other words, the EUR/USD pair can fluctuate up to 40 pips against you, but not more. This size stop-loss, together with your 2% risk-limit, implies a position size of no more than 2,500 units of base currency (EUR).
If your trading platform allows you to trade in individual units of currency, then your position size will be 2,500 units.
If your platform allows you to trade in whole numbers of micro-lots, then your position size will be 2 micro-lots.
If your platform allows you to trade in mini-lots or standard lots (but, not in smaller lot sizes), then you can’t even place a trade with such a small account balance, without violating your 2% risk-limit.
Let’s say your position size is 2,500 units (which your platform may refer to as 0.025, which means 0.025 standard lots). How much actual leverage are you using? Your position size in dollars = 2,500 EUR/USD = €2,500 = $3,250 (at current EUR/USD prices). Your account balance is $500. [B]So, your actual leverage used = $3,250 / $500 = 6.5:1.[/B]
Your broker allows you to use [B]up to[/B] 1000:1 leverage, but your [B]risk management[/B] has limited your actual leverage used to 6½:1.
And you really didn’t even have to consider how much leverage you were actually using.
I would say the leverage is not the killer; but leverage combined with margin is. Your risk/reward ratio must match your account balance. Say, with x10 leverage if you could buy a 1 lot, with x100 leverage you can buy 10 lots. [B][U]But that does not mean you should.[/U][/B]
See, you can earn as much as 100 times more, but if you were to lose, you will lose x100 as well, maybe wiping out your entire account balance in a matter of minutes. Therefore use a high leverage, but trade small lots.
It all depends on your capital. When you have a huge capital, you can take certain risks. I prefer to use 5% of whatever capital I have to minimize risk. However, when using a high leverage, you must pay attention to margin. I think 1:100 is a good choice for a beginner who is not ready to take risk yet.
i don’t look at the 100:1 or 500:1 leverage that my broker / platform applies to my account. it’s a useless number, in reality.
the only leverage that matters is this one:
leverage = position size being opened / account balance at time of the position being opened
and that leverage should NEVER be more than 10. and as your balance grows, you will likely eventually need to reduce that to 5 or 2 simply because if your balance gets to $500,000 then you’d be trying to put on a $5M position which some brokers may limit and/or you may start to skew the markets just a bit and/or that large position can burn up extra pips of the spread (you’d be affecting the liquidity of the current market).
also, keep in mind that as your account shrinks due to losing traders, the position you take MUST ALSO REDUCE by an equivalent amount so that you’re keeping the same actual leverage (or again, maybe scale back the position a bit more if you think you may be acting too aggressively)
that’s it, that’s all. leverage = position / balance. the end.
Nice explanation Clint. I think when it comes to leverage 1:500 is my preference which works great with my trading style and strategy. I think the biggest mistake traders make is to blame leverage for their losses which is ridiculous. Leverage is a tool, maybe the best tool in trading, but you need to understand how to use it in order to benefit from it.
Leverage is like free drinks inside the casino. Leverage is not the one to blame, we are the stupids for using it. You have to be smart for taking advantage of it but you must not let it be used against you.
Using 1:2 or 1:5 is smart, using it all is just stupid. It is only usefull at opening of each trade after that wheter you cut losses and get out fast or stick onto winners but in both scenarios leverage is not longer needed.
