This
is a question that has been asked, argued and pondered among beginners and Fx
Veterans who are tempted to generate huge profits. The question is; how much Leverage should I use? Now how
would you answer that question?
First of all, a trader needs risk/money
management rules when deciding how much leverage to use. One of the time tested
and trusted rule to apply is to risk
only 1%, or less, of deposited capital on a given a trade. Now what does
that mean? Simply put, the dollar amount at risk should not exceed 1% of
deposited capital. So if you are taking a trade where the risk is $1000, your account size must be at
least $100,000. If you are risking $100 per trade, your account size
should be at least $10,000, and if you
are risking $10 per trade, the
account size should be at least $1000.
Find out always what the 1% of your deposited capital is on a given trade.
You
must have heard people saying leverage is a “double edged sword”. True, Forex trading offers a high leverage in
the sense that for an initial margin requirement, a trader can build up and
control a huge amount of money, and high leverage means high risk. When
you are right on your trade this leverage increases your profits. When you place
a wrong trade that same leverage compounds your losses, and that is detrimental
to your trading account. However, too many a trader fall victim to the
temptation, which leverage brings about. When a trader allows greed becloud his
sense of judgment, you tend to fight the market, which is something crucial for
success. When that happens, a trader may hopelessly try to hastily win back his
losses that were created by high leverage, can eventually wipe out his account.
That is why it is important to develop and stick to your plan, strategy and
realistic goals. Leverage therefore,
should be used with extreme caution.
You
may be wondering still, how much leverage is needed mathematically/practically?
Answer: It should be based on the size
of your trading account. If your trading account is $10,000, the trader can
risk $100/trade which is 1% of $10,000 trading account. If a trade develops
which has a 300 pip risk (difference between entry and stop loss), the trader
can take 3 micro lots, which results in a $90 risk. In this case, Moving
Averages leverage is needed. Taking a trade such as this means $3000 (3 micro
lots) is deployed and the account more than covers such a transaction.
If
a trade arises with a 75 pip stop loss, then you can still risk up to $100. In
this case, you can take 1 mini lot ($75 at risk) and 3 micro lots ($22.5 at
risk). If you take 1.3 mini lots total, your risk is $97.5, which is just below
your $100 risk limit. 1.3 mini lots is $13,000 worth of currency though, and
you only have $10,000 in your account, so you will need to use leverage. At
least 2:1 is to be preferred in this case, as that will give you the ability to
trade 20,000 in currency which is 2 x your $10,000 in your trading account,
which is more than enough to take this $13,000 position.
However,
when multiple positions are taken at the same time you will need to utilize
more leverage, such 5:1 or 10:1. Each trade could have a different stop loss,
so it is better to have slightly more leverage than not enough. If you have
extra leverage, you don’t need to use it.
With
the practical examples we’ve provided, you can accurately calculate how much
leverage you really need for your account size. Many traders may find they
actually don’t even need leverage, but having a small is beneficial if it is required. Never forget to apply well
thought out money management plan. Remember, it is professionally advised that by
risking 1% of capital per trade, you will find very little need for a huge
leverage.