Forex Leverage Explained –
Most forex brokers will offer us leverage, this can be as low as 1:1 or as high as 1:500. There are 2 types of leverage. Margin leverage and real leverage.
When we open any trade we have to give our broker a deposit from our trading account. If we wish to open 1 standard lot we are buying 100,000 units of currency. Lets say we want to open 1 standard lot USD/CAD and we trade with a dollar account.
Without leverage we would have to deposit $100,000 with our broker to open a single trade. To trade safely we would need account size in excess of $4,000,000. Without margin leverage it is almost impossible for private traders to trade the forex market.
The leverage offered by brokers allows private traders to open trades that would normally be too large for their accounts. Say we open a 1 standard lot of USD/CAD but this time we have a leverage of 1:100. Now instead of needing $100,000 we only need 1% to open our trade, which is $1,000.
Margin leverage allows private traders access the forex markets.
Margin Leverage can be a double edged sword. This happens because margin leverage allows us to use lot sizes that are to large for our account trading. Therefore we have to be careful to not over trade and blow up our accounts.
Real leverage is measured by the amount of money we have at risk when trading.
$2.50 per pip USD/CAD
Stop loss 200 pips
We open 1 trade with 10 standard lots and we are using 1:500 leverage on our account. This means we are buying 1,000,000 units of currency.
To open the trades we would need to deposit only $500. (High broker leverage has made these trades possible) This would leave $9,500 dollars for our account margin. (see margin section for more detailed explanation).
The trade goes against us and hit its stop loss of 200 pips
$2.50 (per pip per lot) x 10 (lots) = $25 per pip for this trade.
$25 x 200 pips = $5,000 loss.
Our trading account has taken a 50% loss because high broker leverage allowed us to open to many trades. On this trade Real leverage combined with margin leverage has caused massive losses.
Real leverage means total potential capital loss on the trades. In this instance $5,000 was the potential loss.
$2.5 per pip. USD/CAD
Stop loss 200 pips with a 5% maximum account loss. ($2.50 pip x 200 stop loss)
We open 1 trade with 1 standard lots we are using 1:100 leverage on our account. We buying 100,000 units of currency.
To open the trade we would need a deposit of only $250. This would leave $9,750 dollars for our account margin.
Again we hit our stop loss. This time however the result is different.
$2.50 (per pip per lot) x 1 (lots) = $2.50 per pip for this trade.
$2.50 x 200 pips = $500 loss for trade
This time the trader has managed their real leverage risk to a maximum of a 5% loss. Even though we have a losing trade this trader has survived and is able to make another trades.
How to control your real leverage.
This is what this website is about. Controlling our risk while keeping us trading. Take a look at money management, risk of ruin and forex margin explained to see how we can reduce our real leverage whilst making the most of margin leverage.
By controlling our trading risk we are allowing our trading systems the time to make money.