Why is high margin considered bad?

[willsucceed]

Ok i have been around the forums for a while and i am the first to admit i am not the sharpest knife around, especially since i am math challenged. Truth is i still struggle understanding the basics of leverage.

For example lets say i have two forex accounts. Both start with balances of 5k. One account is 100:1 leveraged and the other is 400:1 leveraged. I place a trade simultaneously on both accounts purchasing a full lot of EUR/USD at the price of 1.3790. For the 100:1 leveraged account this means my used margin is $1000 and my unused margin is $4000. On my 400:1 leveraged account my used margin is only $250 and my unused margin is $4750.

First of all it seems much safer with the 400:1 leveraged accout since i have more unused margin to play with in case the position goes against me.
Now suppose the price drops to 1.3740. So i close out at -50 pips. Now the pip value is worth $10 a pip so i lose $500 on both accounts right? It seems like high leverage is win win since you only have to put less money on deposit for used margin. However i must be wrong since i hear high leverage is dangerous. So how is this?

[halo3plz]

leverage is kind of hard to explain without using math examples… yuck. in 400:1 leverage, a 5k account gives you 2million dollars of available capital. i think you are safe as long as you dont trade too large.

above all, i try to preserve my capital and live to trade another day. i only risk 5% of my account per trade. 2 mini lots with a 20 pip stop.

[mugen]

High leverage is a quick way to wipe out your entire account if you’re trading too large.

You’re trading too large when you open a large enough position where your account balance isn’t high enough to handle the typical fluctuations in a currency pair in the time frame that you’re trading. This would result in a margin call.

Have your account set at whatever leverage you prefer, with proper risk management it won’t matter. Most people recommend a lower amount of leverage to try to prevent people from trading too large for their strategy/account balance.

[rhodytrader]

For example lets say i have two forex accounts. Both start with balances of 5k. One account is 100:1 leveraged and the other is 400:1 leveraged. I place a trade simultaneously on both accounts purchasing a full lot of EUR/USD at the price of 1.3790. For the 100:1 leveraged account this means my used margin is $1000 and my unused margin is $4000. On my 400:1 leveraged account my used margin is only $250 and my unused margin is $4750.

First of all it seems much safer with the 400:1 leveraged accout since i have more unused margin to play with in case the position goes against me.
Now suppose the price drops to 1.3740. So i close out at -50 pips. Now the pip value is worth $10 a pip so i lose $500 on both accounts right? It seems like high leverage is win win since you only have to put less money on deposit for used margin. However i must be wrong since i hear high leverage is dangerous. So how is this?

You’ve touched on a key point here, perhaps without realizing it. Everything comes down to your position size, not your available leverage. Given the same position size, your profits and losses are the same regardless of the leverage you employ. The only difference between a 100:1 account and a 400:1 account is that in the latter case you can put on more trades with the same amount of money.

Using 400:1 leverage is NOT safer. How much margin you need to commit to a trade is not at all related to how risky a trade is. It comes down to the size of the trade you put on in relation to the size of your account. Higher leverage is consider more risky because it allows the trader to take on larger positions (or more of them) relative to their account balance, thereby increasing their risk level.

As noted in another post, think in terms of % of your account at risk and don’t get fixated on leverage.

[willsucceed]

You’ve touched on a key point here, perhaps without realizing it. Everything comes down to your position size, not your available leverage. Given the same position size, your profits and losses are the same regardless of the leverage you employ. The only difference between a 100:1 account and a 400:1 account is that in the latter case you can put on more trades with the same amount of money.

Using 400:1 leverage is NOT safer. How much margin you need to commit to a trade is not at all related to how risky a trade is. It comes down to the size of the trade you put on in relation to the size of your account. Higher leverage is consider more risky because it allows the trader to take on larger positions (or more of them) relative to their account balance, thereby increasing their risk level.

As noted in another post, think in terms of % of your account at risk and don’t get fixated on leverage.

Just wanted to say thx for the repy Rhody. I have considered this and the end result is the high margin is not inherently bad, rather it is a tempation for traders (especially newbies) to overtrade by taking positions that are too large for them. So for someone that is disciplined it is not relevant what leverage you have on your account, as long as limit your trades to be a small percentage (say 1%) of your overall account.

[rhodytrader]

Just wanted to say thx for the repy Rhody. I have considered this and the end result is the high margin is not inherently bad, rather it is a tempation for traders (especially newbies) to overtrade by taking positions that are too large for them. So for someone that is disciplined it is not relevant what leverage you have on your account, as long as limit your trades to be a small percentage (say 1%) of your overall account.

Exactly right. I would only change one thing. In your last sentence, I would change “limit your trades” to “limit your risk”. That might not seem like a big difference, but it is. Trade size is combined with pips risked to get position risk. If you focus only on trade size, you will probably overtrade at times and undertrade at others.