Today I learnt a very important lesson on leverage thanks to a call from an FXCM representative...
I have always had a problem understanding the concept. I will attempt to clarify the concept here in an attempt to help myself understand and for you guys to critique in case I got anything wrong.
It is truly a double edged sword. For a novice trader such as myself, it helps to keep my leverage low. There are several brokers out there that promote their accounts using exceptionally high leverage for example 200 or even 400 to 1 leverage. This is DANGEROUS especially for beginning traders.
Imagine leverage as the gate keeper to your equity, your capital your most prized possession. As a beginning trader I have always had a problem staying true to my pre-determined lot size and sometimes days get crazy and I end up over leveraging my account, sometimes this would be a good thing as I may have ended up successful in my trades for that day, but sometimes this would be bad drastically depleting my account to the point of no return.
By keeping you leverage small the gate keeper safe guards your funds by requiring a higher margin requirement in order for you to place a trade.
Let me explain with numbers, lets say on a $10,000 account with 100 to 1 leverage the margin requirement in order for you to place a trade of 1 standard lot may be $100.
If you are trading a $10,000 account this would leave $10,000 - $100 (margin requirement) = $9,900 of equity open and at risk of the whims and fancies of the market (i.e. a terrible trading day). If the leverage requirement is small lets say 5 to 1
The gate keeper withholds $10,000 / 5 = $2000 of equity and would only be allowed to trade 10,000 * 5 = 50,000 which is half a standard lot at anyone point in time
Please tell me if I am misunderstanding this concept, also I am trading a $10,000 usd account what leverage would you guys recommend.
Your math here is wrong... 1 standard lot (100k base currency units) with leverage of 1:100 requires margin of approx US$ 1 000, depending on the exchange rates involved. Equally 5:1 would require margin of ~ US$ 20 000. Simply calculated as 100000/100 and 100000/5.
Position sizing should be adjusted according to your strategy and risk tolerance. I do not think it is appropriate to say that trading with leverage of up to 10:1 is safe, the rest is suicide... it is individual.
1:5 would be pretty secure I think. I have trade with low leverage for some time now and when I wanted more profit I added funds to my account and never ever would dream about increasing leverage again ... so much less stressful than hoping your account will survive this 1:100 trade you just opened ...
A leverage of 1:5 would mean I would require a capital of $20,000 to trade 1 standard lot?
So an account balance of lets say $8,000 with a leverage of 1:5 on the account, my max open positions on aggregate would have to total 8,000 /20000 = 0.4 lots.
If that is the case that is extremely low but I can see why its safe. I think I am comfortable with using a leverage of 1:10 for an account size of $8,000. My max open positions would amount to 0.8 lots.
I trade with tight stops 30-40 pips and have at least two open positions at any one time. This would mean 0.4 lots per open position.
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.
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