Hello again, I am a newbie, and actually mathematically inclined (I think ) but I have a question related to money won or lost. not exactly sure the way leverage works. (I think i have the correct word). so assume you have a ratio of 100:1. you buy 5 at 1.3216. does that mean I bought 500 (5 times 100) shares at 1.3216?
it drops to 1.3192 and you show a net profit of -1200.(I am looking at my demo account).
that is a drop of .0024. if you multiply by 50,000, it results in 1200. why does it work this way?
Let’s use standard forex terminology — it helps to focus the mind.
You have MAXIMUM ALLOWABLE LEVERAGE of 100:1.
You buy 5 what? — Standard lots (= 100,000 units of base currency), or Mini-lots (= 10,000 units of base currency),
or Micro-lots (= 1,000 units of base currency) ?
Let’s say that you bought 5 mini-lots of EUR/USD.
You did not buy 500 of anything. You bought 5 mini-lots (NOT shares) of the EUR/USD currency pair.
Only a mathematician would refer to a LOSS as a negative “net profit”.
You bought EUR/USD at 1.3216, and you sold at 1.3192. You took a 24-pip loss on a 5-mini-lot position.
Assuming your account is denominated in USD, then your dollar-loss is: 24 pips x $1/pip/mini-lot x 5 mini-lots = $120 loss.
(If your account is denominated in some other currency, then this loss would be converted to your account currency.)
Notice that we calculated your loss without saying a word about leverage. Nothing got multiplied by 50,000. There’s no “1200” in this calculation (unless you were trading standard lots, in which case your loss would be $1,200).
Well, you don’t NEED leverage, but it’s nice to have. In the example above, you bought 50,000 units of base currency; that’s €50,000 in this case.
If your account balance was equal to or greater than €50,000 PLUS the spread on 5 mini-lots PLUS the loss you took —
then, you financed the whole fiasco with your own cash, and you used NO leverage.
But, if you had only €5,000 in your account, then you put on a position which was 10 times the size of your account, and you used 10:1 ACTUAL leverage.
So, what’s the 100:1? That’s the MAXIMUM leverage your broker will allow you to use (and only a fool would use that much).
Also, the 100:1 MAX leverage determines the amount of MARGIN that your broker sets aside (to protect himself, not you) when you open a position. In the example above, your position was €50,000, and the margin set aside was 1% of this position size, or €500. This margin amount is basically “escrowed”, because it’s not available to you for covering losses on this trade, but you will get it back when the trade is closed.
Clint thanks for the detailed response.
the math is basic enough, but I still dont get the reasoning.
to me, its kind of like having a 500 dollar max bet with your bookie, he multiplies everything by 100, and then stops at 500 if need be.
i.e., you bet 10 dollars, you multiply by 100 (=1000), but it is capped at 500.
even taking into account that you can “break up your bet” i.e, sell half (or 1/3) of what you bought, etc., I just dont see the need.
I guess its kind of irrelevant, though for now. maybe along the way I will understand the need to do it this way.
Simply put, leverage allows you to trade a larger portion of your capital if you choose to do so. The option is there if you want to take it, but it is not recommended because it’s basically one trade and you are done for if it goes the wrong way.
leverage confuses a lot of newbies so let me attempt to explain it in its simplest form.
For the sake of this example lets say the GBP/USD was trading at parity, 1GBP = 1 USD
you have an account balance of ÂŁ1000
if you were not using any leverage and you bought ÂŁ1000 worth of the GBP/USD if it appreciated by 1%, IE up to 1.0100 your account balance would now be ÂŁ1010.
a 1% increase in equity
However if you were using leverage of 100:1 for this trade
you would in fact be buying ÂŁ100,000 instead of only ÂŁ1000
the reason you can do this is because the broker basically lends you the other ÂŁ99,000
so if the GBP/USD now increases by 1% up to 1.0100
you will make a 100% gain and double your account size to ÂŁ2000 instead of a measly 1% gain
so you now have the potential to make 100x more from the same movement.
However this is a double edged sword and with leverage you of course have the ability to lose 100% of your account with only a 1% movement.
this is why money management is essential when it comes to utilising leverage to increase your trading profits.
i hope this has helped make leverage a little clearer to you
if not feel free to post more questions and we’ll all try to answer as best we can
) but I have a question related to money won or lost. not exactly sure the way leverage works. (I think i have the correct word). so assume you have a ratio of 100:1. you buy 5 at 1.3216. does that mean I bought 500 (5 times 100) shares at 1.3216?