Question about leverage vs "true leverage"

Beginner Questions
1

I’m going through the course and trying to thoroughly understand leverage and margin. The lessons stress how much risk is associated with using leverage, and is more risky the more leverage you use. I have a question about this.

Consider two scenarios opening a mini account with $50k capital.

Scenario 1:
Opens 20 mini lot positions ($200k).
True leverage is 4:1 ($200k/$50k).
Chooses to use 50:1 leverage with the broker on the positions.
Used margin is $4k ($200k/50).
Usable margin is $46k.
In this scenario, the positions would have to move 2,300 pips for there to be a margin call ($46k/$20/pip).
That is unlikely to happen over the short term. For a pair like EURUSD, that would be about a 20% change in price.

Scenario 2:
Opens 20 mini lot positions ($200k).
True leverage is 4:1 ($200k/$50k).
Chooses to use 5:1 leverage with the broker on the positions.
Used margin is $40k ($200k/5).
Usable margin is $10k.
In this scenario, the positions would have to move only 500 pips for there to be a margin call ($10k/$20/pip).
This seems much much more plausible in the short term. For EURUSD, it would only be about a 4% change in price.

In these two scenarios, the true leverage remains 4:1 in both. The only difference is the amount of leverage used for the positions (50:1 vs 5:1). It seems the 5:1 leverage is more risky than the 50:1, since it takes a much smaller change in price to risk a margin call on the positions. Of course, in scenario 2, if we did get a margin call, we’d still have $40k in the account, whereas in scenario 1, we’d have only $4k. But scenario 2 is much more likely to happen than scenario 1.

When the course says that experienced traders rarely go above 3:1 leverage, and cap it at 5:1, are they talking about “true leverage” or position leverage?

It seems that if one’s “true leverage” (full amount of positions divided by total account) stays below 5:1, then using a higher position leverage is less risky. It uses less of one’s capital as margin for the positions, and so the risk of a margin call is far less.

Am I understanding this correctly, or have I done the math wrong? If experienced traders keep their “true leverage” below 5:1, what do they usually use for their position leverage?

Thank you.

2

Does anyone have any thoughts about this?

3

Scroll down this page traders talked about this.
Here’s a tip if you don’t want to get nasty posts from people who have nothing better to do than write why newbies keep asking the same questions over and over. Ask your question in the search you’ll find other threads discussing what you were interested in. If you still don’t understand then ask your question, that way you will be able to ask better questions and get better answers . Hope that helps
Gp

1 Like
4

Thank you. I read the thread, but I don’t see where they talked about this. They talk about 1:1 leverage, which does not seem like leverage at all.

5

I think I got you. I think this link gives you a better answer. In case the link doesn’t show, google True Leverage/ DailyForex
Gp
PS The thing about leverage being good or bad is it requires an opinion, the problem is everyone has one. When you’re right, you’re a genius when you’re wrong . . .well

6

Hi @JoeHershey, as @gp00053 has suggested above… possibly not the space to ask about Leverage and get a non opinionated answer… Everyone will have a different answer and for a very different reason…

TBO, there is no correct answer, it all depends on your trading style and your appetite for risk…The amount of leverage you use does not alter position sizes, wins or loses per say. It only gives you access to more of the Brokers/LP’s funds to trade with…

The theory is that the less leverage you use, the less positions (smaller lots) you are able to place therefore limiting your risk. The downside, it has a limiting effect on how much ground you can cover and a higher risk of a margin call… as you have stated above.

https://www.xm.com/au/forex-calculators/margin#forex-calculator

Above is a Margin Calculator (XM) which may be of help…

7

Hi,
after reading couple of answer about Leverage and true leverage still i’m confuse. What is the meaning of True leverage. Is both terms are same or not?

8

Hi Dextor, welcome to this forum.

Here’s a quick primer on forex leverage.

• Actual leverage used

In the first post in this thread, Joe Hershey introduced a term — true leverage — which is not commonly used in the forex business, but we can work with it.

His term (true leverage) refers to actual leverage used in a trade.

For a single position, true leverage is simply the notional value of the position divided by trading capital. Since most small retail traders have all of their trading capital deposited with their brokers, we can say that true leverage is position size divided by account balance.

Example: You open a one-mini-lot position in USD/JPY in your $2,000 account. Your position has a notional value of $10,000 (one mini-lot), which is 5 times the size of your account. True leverage is 5:1, regardless of the 50:1, or 100:1, or 200:1 maximum allowable leverage offered by your broker.

For multiple open positions, the concept of true leverage is a little more complicated, depending on the degree to which your various positions are correlated with one another. If you have positions open in USD/JPY, USD/CAD, and USD/CHF, you are seriously exposed to USD-risk, because your three positions are highly USD-correlated. In this case, you should calculate the total notional value of these 3 positions, and use that total in calculating the true leverage you are using.

Example: One mini-lot each in USD/JPY, USD/CAD, and USD/CHF in your $2,000 account. Your combined positions have a notional value of $30,000 (three mini-lots), which is 15 times the size of your account. True leverage is 15:1.

If your multiple open positions are not correlated in an apparent way, you might be using less true leverage than the example above indicates. However, currency correlations can be subtle and hidden. Therefore, the conservative approach is simply to (1) assume that your multiple open positions are strongly correlated, and (2) use the total notional value of all your open positions to calculate the true leverage you are using (just as was done in the example above).

• Maximum allowable leverage (sometimes called account leverage, offered leverage, or broker leverage)

This is the limit placed on your use of leverage. If your broker offers 50:1 leverage, you could open a position with a notional value 50 times the size of your account – but, don’t do it. Using excessive leverage is one of the main causes of blown accounts.

Think of the maximum allowable leverage offered by your broker as similar to the credit limit on a credit card. If you are prudent in your use of credit, you will never come close to hitting the credit limit on your card. Similarly, if you are prudent in your use of FX leverage, you will never come close to hitting the maximum allowable leverage offered by your broker.

1 Like
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its a issue liker that , student and real student . i hope now you will understand the matter.