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Low leverage is dangerous, why?
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togr

Member Since Feb 22, 2011  3977 posts vontogr (togr) Dec 13 2016 at 07:38
Dove_Services posted:
The idea that lower leverage increases risk is intuitively wrong and defies basic financial logic. I am amazed by the conflation in logic used to make such an argument. Leverage is simply a form of financing mechanism. Leverage vs no leverage is just financing structure between the use of debt vs no debt. Your capital (equity) put to risk is still the same regardless on the level of leverage. What changes is the trigger mechanism to stop out your position. In the real world, if you borrow to invest and you looses it entirely the lender will go after you. In the forex market, your broker cuts your position before the leverage crystallise into a real debt. What doesn't change is that the capital employed to earn the return remains the same regardless of leverage. In other words, the risk to your capital is the same regardless of leverage except that the broker automatically cut your position before it becomes a debt issue.

A good example is the USDCHF debacle where some clients ended up in negative equity. Fortunately for some there was a get out of jail cut because of the way the terms were structured and the fail safe mechanism of the brokers did not work as planned. I would not bet on it that in a future black swan event, the same get out of jail card will be available.


@Dove_Services
no, you are wrong. Leverage simple determines margin required by broker to allow you to open trade.
(there are of course also trade cost like comission, spread, markup, swap, etc..)
So without leverage you can open trade of 0.01 lot of EUR for the cost of $1060. So you would need at least 1100 to open even the smallest trade possible. No these 1100 US is at risk. There are various reasons including broker bankrupt or aml policy or whatever could happen.
So WITHOUT leverage you are risking these 1100 to achieve very very decent profit - trading just 0.01 lot. You would not even be able to execute another trade until the first one close (or get 1060 with 0.01 lot)

With good leverage you can trade 0.01 with $100. With good money management it could be safe and very profitable.
You can even open 10 small accounts spreading the risk over different
A. brokers
B. systems
C. pairs
etc...

So once again low leverage is risky. As to achieve your profit goal you need to risk more capital.

I like what I trade, I trade what I like
shirley_F

Member Since Nov 25, 2015  41 posts Fredrick (shirley_F) Dec 13 2016 at 11:20
The leverage serves as a multiplier to enable you to open positions much larger than your initial investment. To see the relation between leverage and risk, we need to isolate these 2 variables and consider all other trading conditions as equal. Risk corresponds to loss (as no one is risking to win something).

Example:
Let's assume you have 10,000 EUR in your account. With 1:1 leverage, you will be able to open max 0.1 lot on EURUSD (10,000 EUR) and if the price moves by 0.1 pip in the opposite direction, you lose 0.1 USD. You will end up with 9,999 EUR. With leverage of 1:100, you will be able to open max 10 lots on EURUSD (1,000,000 EUR) and if the price moves by 0.1 pip in the opposite direction, you lose 10 USD. You will end up having 9,990 EUR. It goes on like that when you increase the leverage. Again, we are talking about the money you risk on losing when closing the trade.

Another question to consider: How long you may stay in the market with an open losing position if you leverage is 1:1 or 1:1000, hoping for the price to revert in your favour?

The amount you put in your account is your initial investment. It is not the amount you risk at once. The amount you actually risk is the one directly connected to a single price movement. The higher the leverage, the stronger is the negative impact on your balance in case of a negative price movement as the effect multiplies.

This is how I see and understand the relation between leverage and risk. Of course there are other factors involved with risks in trading but here we look just at how those 2 are connected.

togr

Member Since Feb 22, 2011  3977 posts vontogr (togr) Dec 13 2016 at 13:46
shirley_F posted:
The leverage serves as a multiplier to enable you to open positions much larger than your initial investment. To see the relation between leverage and risk, we need to isolate these 2 variables and consider all other trading conditions as equal. Risk corresponds to loss (as no one is risking to win something).

Example:
Let's assume you have 10,000 EUR in your account. With 1:1 leverage, you will be able to open max 0.1 lot on EURUSD (10,000 EUR) and if the price moves by 0.1 pip in the opposite direction, you lose 0.1 USD. You will end up with 9,999 EUR. With leverage of 1:100, you will be able to open max 10 lots on EURUSD (1,000,000 EUR) and if the price moves by 0.1 pip in the opposite direction, you lose 10 USD. You will end up having 9,990 EUR. It goes on like that when you increase the leverage. Again, we are talking about the money you risk on losing when closing the trade.

Another question to consider: How long you may stay in the market with an open losing position if you leverage is 1:1 or 1:1000, hoping for the price to revert in your favour?

The amount you put in your account is your initial investment. It is not the amount you risk at once. The amount you actually risk is the one directly connected to a single price movement. The higher the leverage, the stronger is the negative impact on your balance in case of a negative price movement as the effect multiplies.

This is how I see and understand the relation between leverage and risk. Of course there are other factors involved with risks in trading but here we look just at how those 2 are connected.


@shirley_F
No. You cant open 0.1 lot on 10,000 EUR account without leverage.
Even though you will have margin to do it you wont be able to pay comission/spread as the whole equity is used as margin.
Also you can get margin call if all your equity is used for margin.

So the right outcome is if you wish to trade 0.1 lot you need just 1,000 balance and good leverage.
Thus again and again you are risking 10x less (10,000 vs 1,000) to get the same 10 EUR profit.
So using low leverage is forcing you to risk more to get the same profit.

I like what I trade, I trade what I like
kebayamwamba

Member Since Sep 16, 2009  115 posts Osiris (kebayamwamba) Dec 13 2016 at 15:40
with low leverage 99% of retail traders would never trade FX...

the margins would be so high...you will need at least minimum $10 000

I bet ...99% of traders here dont have that amount sitting quietly waiting

Leverage is good

No one puts a gun on your head to open huge lots

can the pursuit of wealth be automated?
BaldoN

Member Since Feb 12, 2016  522 posts Baldo (BaldoN) Dec 13 2016 at 15:59
Leverage is a weapon. If you know how to use it properly its better for you. If you don’t know it will easily kill you. The bigger the leverage the bigger the weapon. Use it wisely and you are good to go. Misuse it and you are dead.

togr

Member Since Feb 22, 2011  3977 posts vontogr (togr) Dec 13 2016 at 15:59
kebayamwamba posted:
with low leverage 99% of retail traders would never trade FX...

the margins would be so high...you will need at least minimum $10 000

I bet ...99% of traders here dont have that amount sitting quietly waiting

Leverage is good

No one puts a gun on your head to open huge lots


Exactly

I like what I trade, I trade what I like
togr

Member Since Feb 22, 2011  3977 posts vontogr (togr) Dec 13 2016 at 16:00
Moreover even accounts with very low leverage were wiped and these can be seen on MFB.

I like what I trade, I trade what I like
alexforex007

Member Since Oct 11, 2013  694 posts alexforex007 Dec 13 2016 at 23:07
Interesting opinions from all of you, always trying to keep an open mind.

shirley_F

Member Since Nov 25, 2015  41 posts Fredrick (shirley_F) Dec 14 2016 at 07:55
togr posted:
So using low leverage is forcing you to risk more to get the same profit.


This is wrong. With low leverage you actually not risk but secure more money in your account in case of reaching your broker's stop out level, meaning you will end up having more after your trade is automatically closed.

Example:
If you trade 0.1 lot on EURUSD (10,000 EUR) and your broker's stop out is set to 50%, in case of negative price movement, with a leverage of 1:100 (margin required - 100 EUR) you will reach the stop out having 50 EUR left in your account. However, with a leverage of 1:1000 (only 10 EUR required as your margin) you will reach the stop out having 5 EUR. Therefore - with the higher leverage you are losing 10x more, meaning you are putting at stake (risking) 10x more money. It's is that simple. Once again, I am talking about the connection between risk and leverage, not between profit and leverage, as this is the topic of the discussion. It is also true that if you risk more you could earn more. But danger comes with the risk of losing.

An account can be wiped out with any leverage but in normal conditions (no flash crashes or black swan events) the lower the leverage, the slower the account can be wiped out. No wonder why brokers who trade against their clients always recommend using a high leverage focusing on the big profits and ignoring the risk of big losses. They know that when they clients lose, they make a good profit and faster smiley

To make sure my example earlier is clear - we can simply say that we want to invest 10,000 EUR (having in our account enough funds to do it, considering margin calls, spreads, commissions etc.). If you trade these 10K at 1:1 leverage, you risk losing 0.1 USD for every pip of adverse price movement, while if you trade the same 10K at 1:100 leverage, you risk losing 10 USD for every pip of adverse price movement. This means that higher leverage is riskier.

@kebayamwamba Don't get me wrong, I am not against the leverage in general. In fact leverage makes trading accessible to all small investors which is good and you are right that no one forces us to open large trades. I just wanted to explain with an easy to calculate simple example why the statement 'low leverage is more risky' is wrong. I prefer actually trading FX with a leverage of not more than 1:100, risking less.

@togr Your attempt to challenge a common truth deserves admiration and this was a nice and solid attempt. It's also important to present both sides of the coin. Wish you good luck in trading at high leverage as it seems you have the skills to sustain it over long term and are happy with such conditions!

togr

Member Since Feb 22, 2011  3977 posts vontogr (togr) Dec 14 2016 at 07:56
BaldoN posted:
Leverage is a weapon. If you know how to use it properly its better for you. If you don’t know it will easily kill you. The bigger the leverage the bigger the weapon. Use it wisely and you are good to go. Misuse it and you are dead.


@BaldoN
That is a perfect definition. :)

I like what I trade, I trade what I like
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HIGH RISK WARNING: Foreign exchange trading carries a high level of risk that may not be suitable for all investors. Leverage creates additional risk and loss exposure. Before you decide to trade foreign exchange, carefully consider your investment objectives, experience level, and risk tolerance. You could lose some or all of your initial investment; do not invest money that you cannot afford to lose. Educate yourself on the risks associated with foreign exchange trading, and seek advice from an independent financial or tax advisor if you have any questions. Any data and information is provided 'as is' solely for informational purposes, and is not intended for trading purposes or advice. Past performance is not indicative of future results.