What Is Leverage?
Leverage involves borrowing a certain amount of the money needed to invest in something. In the case of Forex, that money is usually borrowed from a broker.
Forex trading does offer high leverage in the sense that for an initial margin requirement, a trader can build up and control a huge amount of money.
Example Situations:
You buy 2 mini lots of EUR/USD. Your true leverage is 40:1 ($20,000 / $500). You place a 30-pip stop loss and it gets triggered. Your loss is $60 ($1/pip x 2 lots).
You have just lost 12% of your account ($60 loss / $500 account). Your account balance is now $440.
Day 2. You decide to double up and you buy 4 mini lots of EUR/USD. Your true leverage is about 90:1 ($40,000 / $440). You set your usual 30-pip stop loss and your trade loses. Your loss is $120 ($1/pip x 4 lots).
You have just lost 27% of your account ($120 loss/ $440 account). Your account balance is now $320.
A four trade losing streaks is not uncommon. Experienced traders have similar or even longer streaks.
Leverage involves borrowing a certain amount of the money needed to invest in something. In the case of Forex, that money is usually borrowed from a broker.
Forex trading does offer high leverage in the sense that for an initial margin requirement, a trader can build up and control a huge amount of money.
Investors use leverage to profit from the fluctuations in exchange rates
between two different countries. The leverage that is achievable in the Forex market is one of the highest that investors can obtain. Leverage
is a loan that is provided to an investor by the broker that is handling
his or her Forex account. When an investor decides to invest in the Forex market, he or she must first open up a margin account with a
broker. Usually, the amount of leverage provided is either 50:1, 100:1
or 200:1, depending on the broker and the size of the position the
investor is trading. Standard trading is done on 100,000 units of
currency, so for a trade of this size, the leverage provided is usually
50:1 or 100:1. Leverage of 200:1 is usually used for positions of
$50,000 or less.
Here is a
sample chart of how much account balance changes if prices moves depending on
your leverage.
Leverage
|
% Change in Currency Pair
|
% Change in Account
|
100:1
|
1%
|
100%
|
50:1
|
1%
|
50%
|
33:1
|
1%
|
33%
|
20:1
|
1%
|
20%
|
10:1
|
1%
|
10%
|
5:1
|
1%
|
5%
|
3:1
|
1%
|
3%
|
1:1
|
1%
|
1%
|
Example Situations:
Day 1. A mini account with $500 which trades $10K mini lots and only requires .5% margin.
You buy 2 mini lots of EUR/USD. Your true leverage is 40:1 ($20,000 / $500). You place a 30-pip stop loss and it gets triggered. Your loss is $60 ($1/pip x 2 lots).
You have just lost 12% of your account ($60 loss / $500 account). Your account balance is now $440.
Trade #
|
Starting Account Balance
|
# Lots of Used
|
Stop Loss (pips)
|
Trade Result
|
Ending Account Balance
|
1
|
$500
|
2
|
30
|
-$60
|
$440
|
Day 2. You decide to double up and you buy 4 mini lots of EUR/USD. Your true leverage is about 90:1 ($40,000 / $440). You set your usual 30-pip stop loss and your trade loses. Your loss is $120 ($1/pip x 4 lots).
You have just lost 27% of your account ($120 loss/ $440 account). Your account balance is now $320.
Trade #
|
Starting Account Balance
|
# Lots of Used
|
Stop Loss (pips)
|
Trade Result
|
Ending Account Balance
|
2
|
$440
|
4
|
30
|
-$120
|
$320
|
Day 3. You believe the tide will turn so you trade again. You buy 2 mini
lots of EUR/USD. Your true leverage is about 63:1. You set your usual 30
pip stop loss and lose once again! Your loss is $60 ($1/pip x 2 lots).
You have just lost almost 19% of your account ($60 loss / $320 account). Your account balance is now $260.
Trade #
|
Starting Account Balance
|
# Lots of Used
|
Stop Loss (pips)
|
Trade Result
|
Ending Account Balance
|
3
|
$320
|
2
|
30
|
-$60
|
$260
|
Day 4. You are getting frustrated. You try to think what you are doing wrong. You think your setting your stops too tight.
The next day, you buy 3 mini lots of EUR/USD. Your true leverage is
115:1 ($30,000 / $260). You loosen your stop loss to 50 pips. The trade
starts going against you and it looks like you are about to get stopped
out yet again! But what happens next is even worse! You get a margin call!
Since you opened 3 lots with a $260 account, your Used Margin was
$150 so your Usable Margin was a measly $110. The trade went against you
37 pips and because you had 3 lots opened, you get a margin call. Your
position has been liquidated at market price.
The only money you have left in your account is $150, the Used Margin that was returned to you after the margin call.
Trade #
|
Starting Account Balance
|
# Lots of Used
|
Stop Loss (pips)
|
Trade Result
|
Ending Account Balance
|
4
|
$260
|
3
|
50
|
Margin Call
|
$150
|
The only money you have left in your account is $150, the Used Margin that was returned to you after the margin call.
The Summary of your trading account has gone from $500 to
$150. A 70% loss! It would not be very long until you lose the rest.
| Trade # | Starting Account Balance | # Lots of Used | Stop Loss (pips) | Trade Result | Ending Account Balance |
|---|---|---|---|---|---|
| 1 | $500 | 2 | 30 | -$60 | $440 |
| 2 | $440 | 4 | 30 | -$120 | $320 |
| 3 | $320 | 2 | 30 | -$60 | $260 |
| 4 | $260 | 3 | 50 | Margin Call | $150 |
A four trade losing streaks is not uncommon. Experienced traders have similar or even longer streaks.
To avoid such a catastrophe, Some Forex traders use low leverage and most use their leverage at 5:1 but rarely go
that high and stay around 3:1. Other experienced traders succeed because they use proper capitalization which allows to realize losses
that are very small and allows
you to trade another day.
