David Waring

In our last lesson we looked at some of the logistics of leverage on our real time demo trading accounts. In today's lesson we are going to continue our leverage discussion with a look at several examples of trades using leverage and the amplification of potential risk and reward that comes with that.

As we covered in our last lesson the real time demo trading platform which we are using, comes with a default leverage maximum of 100 to 1. What this means is that for every contract of 100,000 of the base currency that you open, you need at least $1000 of margin in your account to avoid receiving a margin call and having that trade closed.

The important thing to understand here is that this 100 to 1 leverage is the maximum offered on this particular demo account and the level at which if you drop below the open positions on your account will be closed. With this in mind it is my opinion (which was formulated from years of trading and watching other people trade) that most successful traders would never put themselves in a position where they would receive a margin call. The reason behind this is that they employ a money management strategy which controls the amount of leverage that they would use on any one trade, and for their account as a whole, something which we talk in depth about in Module 6 of our free beginner trading course in the free course section of the InformedTrades.com site.

In general most successful traders I have seen trade use a maximum leverage at any one time of 5 to 1 and many would consider even this to be too highly leveraged. The amount of leverage used really depends on trading style as much as anything as in general traders who hold positions for short periods of time and cut losses quickly are able to successfully employ higher amounts of leverage than longer term traders who need more breathing room in their trades. To help illustrate how this works from a logistical standpoint lets take a look at a couple of examples:

The best way in my opinion to think about leverage and trading on margin is to always ask yourself the question of: "By how much am I amplifying the gain or loss on my account when opening this trade?"

For this example lets say that I start trading with $100,000 simply because this is an easy round number to work through the math with.

If I open 1 contract of USD/JPY then I am trading $100,000 against the equivalent amount of JPY as we have learned in previous lessons. So if I have $100,000 in my account and I am trading $100,000 USD against JPY, then I am not leveraged as the cash balance of my account equals the position size I am trading.

With this example a 1% movement in the currency pair would represent a 1% gain or loss in the value of my account. As we learned in our last lesson the Used margin column of my account in this example would show $1000 and my Usable margin would show $99,000.

If I open 2 contracts of USD/JPY then I am trading $200,000 against the equivalent amount of JPY. As I have $100,000 in my account and $200,000 in open positions I am leveraged at 2 to 1 as the position size I am trading is twice the value of the cash in my account.

With this example a 1% move in USD/JPY currency pair would represent a 2% gain or loss in the value of my account, thus amplifying the potential gain or loss on this trade by 2 times. In this example the Used Margin Column of my account would show $2000 and my usable margin would show $98,000.

If I open 5 contracts of USD/JPY then I am trading $500,000 against the equivalent amount of JPY. As I have $100,000 in my account and $500,000 in open positions I am leveraged at 5 to 1.

With this example a 1% move in the USD/JPY currency pair would represent a 5% gain or loss on the value of my account, thus magnifying the potential gain or loss by 5 times.

For tonights homework session I recommend working through a couple of examples as I have above with other currency pairs in which the USD is the base currency in the pair. Secondly I encourage you to think about how to go about figuring out the leverage used when the USD is not the base currency in the pair.

This will be the topic of our next lesson so we hope to see you then. As always if you have any questions or comments please leave them in the comments section below, and good luck with your trading!

pan

hey dave

im having a bit of a mental block with leverage. if for example i open a standard account with $25k. that would imply that i am leveraged at 4:1. if i employ a money management risk of 2% of my total account. that would mean i am prepared to lose $500 for being wrong. if i am trading a pair of currencys where the usd is not the base currency, and therefore valued at $10 per pip, does this mean that my initial stop would be 50 pips away from my entry price?

pan

David Waring

Hey Pan,

Good questions. There are two factors that determine how much leverage you are using. The first is how much money you have in your account ($25K in this example) and the second is how large of a position you trade. So if you trade 1 standard contract of 100K then yes you would be leveraged at right around 4 to 1 (I say right around because on currency pairs where the USD is not the base currency it may be a little more it may be a little less as I outline in the lesson). If you trade two contracts then 8 to 1 etc.

If you open an account with $25K and are prepared to risk 2% then yes this is $500 that you are wiling to risk. You are also correct that if you are trading a currency pair where the USD is the second currency in the pair then you are risking $10 per pip, per contract traded.

So with this in mind yes if you were trading 1 contact and only wanted to risk $500 then you would put your stop 50 pips away. If you were trading two contracts then you would put it 25 pips away etc.

Hope that helps. Let me know if there are any other questions.

Best Regards,
Dave

prolog

I'm sorry. I'm lost

Account balance = $100,000
Buy 1 USD/JPY contract
$100,000 / $100,000 = 1


How can the used margin be $1000?

Isn't the used margin supposed to be $100,000?


This is how I understand
If I buy one 100k contract with 1:1 leverage, it means that my used margin will be 100k. (My whole account will be used and exposed)

If I buy one 100k contract with 2:1 leverage, it means that my used margin will be 50k. (Half of the total amount in my account will be used and exposed while another half will remain inactive).

If I buy one 100k contract with 10:1 leverage, it means, that my used margin will be 10k.


Because you mentioned in the Margin video that 100:1 leverage on 100k account gave $1000 used margin.



Is leverage = Contract size / margin size

or

leverage = contract size / account size

?

Tekmnd

Hi again prolog
You must be getting sick of me by now lol

"How can the used margin be $1000?

Isn't the used margin supposed to be $100,000?"

(See my other answer to your other question in another thread.)
The broker only requires you to set aside a minimum margin amount. In this case, it is 1% (100:1 leverage). If you choose to lower your leverage, like in Dave's example, and not trade on leverage, the broker will still only show 1% used even if you set aside the entire $100K.

In Dave's example, he bought $100k with $100K. The broker shows $1K of leverage used, because even though Dave decided to not use leverage (he put up the entire $100K), the broker only secures $1K. Dave could still trade with the other $99k if he is not self-disciplined and chooses to do so. It is Dave’s decision/choice to not use the other $99K.

Keep in mind that a broker is a business. They will allow you to use way more leverage than you should use, because every time you buy or sell, they make money. If you over-leverage yourself and blow out your account, they are making money as they sell off your positions. Much like a casino will give you free beer when you gamble, the broker will give you more leverage than one should use to make money off of un-disciplined traders

Cheers
Tek

prolog

Thanks Tek.
It's clear now


I LOL'ed

Unregistered

Hi Dave,
There's something I don't understand.if you have$100,000 in your account and you buy a $100,000 contract with no leverage, have you not used all your equity to buy that contract.So how can the used margin be $1000 and not $100,000 and how can there be $99,000 available for other contracts?

also ,isn't having two contracts of $100,000 with no leverage the same as having one $100,000 lot or contractwith 2:1 leverage?

fxtrader777

Hello TEK,

I am searching the phrase "losing money in casino is granted by free bear and in forex no one grants you anything" is it in any book mentioned

I am sending a question to TV show and searching for source

thanks

David Waring

Hi There,

Glad to hear from you.

If you have $100,000 in your account and you buy 1 $100,000 contract then you are correct that you are using zero leverage on the account. The Used margin represents the minimum amount that you must have in your account in order to avoid a margin call. More on this below:

Leverage

Hope that helps.

Best Regards,
Dave

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Disclaimer: Trading is risky and can result in substantial financial loss. As always my posts are simply one traders opinion and should not be taken as trading advice. I am not a financial adviser so everyone please do their own analysis and take responsibility for their own trades.