With some forex brokers offering up to 500:1 leverage, here’s how much you’ll really need for various scenarios. Utilize leverage to increase gains, but we also need to maintain strict risk controls while doing it.
500:1 leverage means you can initiate a position valued at 500 times your capital. That could be profitable, or it could wipe out your capital if the price moves 0.2% against you. Leverage varies around the world, with some countries only allowing up to 30:1.There’s no reason to use that much leverage. This article is about finding the balance, where we can still make money, yet aren’t constantly exposed to catastrophe.
Here’s how to figure it all out.
Forex leverage is when a broker provides you with more capital to trade with than what you deposited. This increases your “buying power” and allows you to make trades using this larger amount of capital.
Leverage means you amass profits more quickly than if you just used your own capital. Losses also happen more quickly.
In this article, we’ll look at how leverage works, why forex brokers offer such higher leverage amounts (and this is changing), and how much to take and use.
How Forex Leverage Works
When you check out forex brokers, or open a forex account, they will typically tell you how much leverage they offer. You also have a choice of how much leverage you accept.
Regardless of how much they offer/provide you with, you decide how much you actually use for your trading.
Leverage is how large of a position(s) you can take in relation toyourcapital.
Assume a broker offers you 100:1 leverage. You have $1,000 in your account. Multiply your capital by your leverage to get your “buying power”. You can take $100,000 worth of positions (100 x $1,000).
If you have 50:1 leverage, you have $50,000 in buying power.
Just because you have this much buying power/leverage doesn’t mean you need to use it.
Assuming you have a $500 deposit and 200:1 leverage. This gives you $100,000 in buying power. That’s a lot on a $500 account. So even though you are able to trade up to 100K of currency, maybe you decide to cap yourself at $15,000, or about 30:1 leverage. You do this by takingposition sizesthat don’t total more than $15,000 (in your account currency).
When you use leverage your buying power increases but doesn’t change how much you have in the account. If you take a $100,000 trade with $1000 in the account, you can only lose $1000. On a $100,000 position, if that price moves 1% against you, you lose your entire $1000. This is why risk must be managed, and is based on our own account balance, not buying power. This is discussed a little later on in the profits/losses section.
Leverage and Margin
You may see leverage listed or advertised another way, as margin.
Some brokers may say they offer leverage up to 50:1. Others may say “2% margin requirement”. This is the same thing. The latter means you only need to put up 2% of your own capital for a trade.
If you have $1,000 and 50:1 leverage, you have $50,000 in buying power.
If you have $1,000 in your account and 2% margin, you only need to utilize 2% of your capital for a $10,000 trade (for example), which is $200. That means you take up to 5 such positions in order to “spend” your whole $1,000 account. In this case, you are also taking positions up to $50,000 (5x$10,000) which is 50:1 leverage (2% margin).
Remember, you don’t need to actually use all the leverage or margin available to you! Regardless of how much leverage you’re offered or choose to take, you can opt to use less leverage based on how you trade.
Many brokers, and countries, have dropped leverage to 50:1 or below, and some are 30:1 or lower.
Leveraged Profits and Losses
Leverage gives you buying power. By extension, that leverage can increase your profits and losses.
Let’s look at a couple of examples.
Assume you deposit $100 into an account and have 100:1 leverage. You can have positions totaling up to $10,000 worth of currency. That’s the maximum; you can have positions totaling less if you want.
Say you like a trade in the EURUSD. You are going to buy at 1.1320 and place astop lossat 1.13. Your risk is 20 pips. Assuming you have a US dollar account, each pip of movement is worth $0.10 on 1,000 worth of currency (a micro lot). This is called the pip value. A micro lot is the smallest amount of currency you can trade with most brokers.
Note that you have $100, yet the smallest position you can take is 1,000 (of the first currency listed in the pair). This means you are already using 10:1 leverage just by trading the smallest positions size.Actually, a bit more than 10:1 because you are buying 1000 Euros which is US$1132 at a rate of 1.1320. Actual leverage is therefore $1132/$100 = 11.32.
You buy one micro lot, which means you are risking 20 pips x $0.10 = $2 of your $100.
That is good. You are using 11:1 leverage, but your risk is controlled with astop loss order. Your risk is $2, or 2% of your $100 account. Risking 1% or less would be better risk management.
Assume you take a profit at 1.3270, which is a 50 pip gain. That means you made $5 (50 pips x $0.10) on your $100 account, or 5%. That is a 2.5:1 reward-to-risk (you were risking $2, and made $5).
That’s amazing, considering that without leverage this trader would not have been able to place a currency trade because they didn’t have enough capital to buy even the smallest amount of currency available.
Next, let’s consider a reckless trader. They just want to use their leverage to make some quick money.
They deposit $1,000 and have 100:1 leverage. They buy a currency pair but they don’t place a stop loss. They think the pair is going up, so they are willing to hold the trade until that happens (scary!).
They buy 100,000 worth of currency. With that much currency, a pip of movement is worth $10. If the price drops 100 pips, this trader’s $1,000 will be entirely lost (100 pips x $10 a pip).
At the time of writing, the EURUSD is moving about 65 pips a day, and most of that movement occurs within about a 10-hour period. So in about 10 hours, this tradercouldlose almost their entire account most days, if trading this way. They could easily lose their entire account within 2 days.
On the flip side, if the price rises 100 pips, they make $1,000 (100 pips x $10). They doubled their account.
Brokers Offer Huge Leverage To Entice You
Currencies don’t move like stocks. You will often hear stock swing traders talk about prices moving 20%, 40%, or 100% within a few days or weeks of acup and handle breakout, for example.
Most major global currencies tend to move 1% or less a day, and a 30% move over a year would be a huge move.
That’s one of the reasons that forex brokers offer high leverage. The high leverage allows traders to capitalize on smaller price moves using larger amounts of capital.Without leverage, trading forex wouldn’t be worthwhile for most retail traders.
There’s also another reason. Forex brokers often target clients with small amounts of capital. They do this by offering high leverage and giving traders with less than several thousand dollars the ability to trade. You can’t trade $100 in any other market effectively, but with leverage in the forex market, you can.
Forex brokers know these small accounts will use the leverage. The small accounts will then pay commissions and spreads on the bigger amounts being traded. The broker makes money off all these small accounts.
Most of these small traders won’t last very long, but there is always someone else with $500 or $100 (or maybe even less) willing to give forex trading a try. Small accounts, enticed in by leverage and the chance for profits, are a steady steady stream of revenue for the forex brokers. Such clients are easily replaceable since there is an endless supply.
Without leverage, those small accounts couldn’t even place a single trade, and the broker’s revenue stream dries up.
How Much Forex Leverage Should You Use
It doesn’t really matter how much leverage you have available to you, because you can always use less.
If you plan to have multiple trades at one time, or you want to day trade, I would opt to take 50:1 leverage.
50:1 should serve most traders just fine. If 30:1 is the maximum available in your area, take that. That is a great amount of leverage as well.
If you are aforex day trader, you will likely use quite a bit of leverage for each trade. Assume you have a 5 pip stop loss and risk 1% of your capital on each trade. On a $1,000 account, that means you can lose up to $10 on each trade. That means you can take a 2 mini lot position (20,000). If you lose 5 pips on 2 mini lots, you will have lost $10, which is the maximum you have allocated for that trade.
Buying two mini lots means you are leveraged 20:1 on that one trade (bought 20,000, but only have $1,000 in the account).
That still leaves some buying power available for another day trade, at the same time, or for a few swing trades.
Swing trades typically require less leverage because the stop loss is often bigger.
Assume you deposit $1000, risk 1% ($10 per trade), and take a trade in the EURUSD with a 30 pip stop loss. You can buy 3 micro lots (3 x $0.10 x 30 pips), which will mean you will lose $9 if your stop loss is hit. On this trade, you are using 3:1 leverage (likely a bit more, since you’re buying micro lots of Euros). You could have many trades like this if you have access to 50:1 or 30:1 leverage.
Or, you could have a day trade as well as multiple swing trades.
The smaller your stop loss is, or the higher the percentage of your account you are willing to risk on each trade, the more leverage you will be using.
Some countries now have a maximum of 30:1 leverage. This will also work just fine for most traders. Swing traders should still be able to take multiple positions at the same time, and day traders should be able to risk 1%, or slightly less (which is good risk management) when using a small stop loss.
Forex Leverage Final Word
If the position sizes don’t make sense to you, read theposition sizingarticle.
If the pip values are confusing, read the pip value article.
50:1. is the legal limit in the US. You can make a lot of money using a little bit of leverage in the forex market. 50:1 gives you more than enough leverage to swing trade and have a day trade or two at the same time.
If you take multiple day trades at the same time, risking 1% of the account on each with a small stop loss, then you may need more than 50:1.
As you consider leverage and opening an account, I would also adviseNOT to take the deposit bonus that many brokers offer. This can seriously complicate withdrawals down the road.
In this article, I used pip values for a US account and only used the EURUSD for simplicity. If you have another account currency, or you have a US account but trade currency pairs that don’t have the USD listed second (USD/JPY, for example) then the pips values will be different. Be sure to understand position sizing and pip values forall the different pairs that you opt to trade.
By Cory Mitchell, CMT
Disclaimer: Nothing in this article is personal investment advice, or advice to buy or sell anything. Trading is risky and can result in substantial losses, even more than deposited if using leverage.
