Leverage: a tool that should not be taken lightly!

Have a question about trading? Any questions are welcome. Go ahead!

Leverage: a tool that should not be taken lightly!

Postby forex_champion » Sun Apr 11, 2010 3:42 pm

Hello everyone! I would like to say first of all that this website has really helped me better understand the Forex world and beyond that it has even given me a thirst for learning more everyday. It's like it's never enough knowledge and I suppose that the more you learn the greater your chance of success is. While I have learned quite some useful information these last 6 months (that's when I started learning) I am not yet ready to swim in the pool for the first time and still have some questions that need to be answered. For instance, leverage still seems a vague subject to me.

Perhaps my lack of understanding is not so much focused on the definition of leverage but more on it's actual everyday use. How is it that leverage happens? If someone could tell me every steps of the way that would help. I think that some example (not theoretical) of the steps one needs to take to enter a trade would help me. I have been trading on a demo account now for about the same time I started learning. As you have probably guessed I am now way better than what I used to be. But still, to succeed in Forex you need to have a proper system and stick to your rules and more importantly you need good money management. I have done the first part, now before even thinking of investing one cent, I need to be crystal clear on the second part.

I would appreciate if someone could tell me precisely how leverage is used. For example, a guy name Peter decides to open an account and puts 10 000 $ in it. He decides he wants to use some leverage and therefore uses a 10:1 to open a standard account.
Right there I need to understand something. Is this chosen before opening an account? Or leverage can be changed later on? My other question is since Peter only has 10 000 and takes a 10:1 leverage his account would now have 100 000. But the margin cost for such leverage is 10% thus his initial 10 000$. Therefore how can he even perform any operation if his usable margin is 0$ (used margin is 10 000$)?

I know that this must be very confusing for all of you and perhaps I'm explaining it so badly that I'm the only one that can understand it in my head. I'm sure that there must be something that I'm not doing right if someone could just enlighten me that would be great!

Thanks to all of you for your time! Hope I can get this question answered...
forex_champion
forex_champion
 
Posts: 13
Joined: Sun Apr 11, 2010 3:37 pm

Re: Leverage: a tool that should not be taken lightly!

Postby forex_champion » Tue Apr 13, 2010 10:23 pm

Hi Rom or Kjell...I don't know how to call you.

Anyways, thank you for your support. You said that you could give me a hand with my questions and I listed my problem on the previous message.

<< I would appreciate if someone could tell me precisely how leverage is used. For example, a guy name Peter decides to open an account and puts 10 000 $ in it. He decides he wants to use some leverage and therefore uses a 10:1 to open a standard account.
Right there I need to understand something. Is this chosen before opening an account? Or leverage can be changed later on? My other question is since Peter only has 10 000 and takes a 10:1 leverage his account would now have 100 000. But the margin cost for such leverage is 10% thus his initial 10 000$. Therefore how can he even perform any operation if his usable margin is 0$ (used margin is 10 000$)? >>

That is what mostly mixes up my understanding on the subject. I know what leverage means...but I don't know how it works. How does the client ask his broker a certain leverage? Is it right before opening a trade? Or is it right before opening an account in which case one would have to close the account in the eventuality that another leverage is desired. For example, if it is indeed chosen when opening an account, the client deposit 10 000$ and chooses a 10:1 leverage to open a standard account thus controlling a total 100 000$. Months later he has 150 000$ in his account. He decides to change his leverage to 5:1 or whatever value he wants, he would then have to cash out his money, close the account and reopen one with the new desired leverage?

Anyhow as you can see I'm not seeing clear here... Thank you for your help! Hope you understand my questions.
Forexchampion
forex_champion
 
Posts: 13
Joined: Sun Apr 11, 2010 3:37 pm

Re: Leverage: a tool that should not be taken lightly!

Postby forex_champion » Wed Apr 14, 2010 6:35 pm

I am presently using FXpro. Which always asks me what kind of lot size I want before entering the market. It could be 0.1, 0.5, 1, 2, 3 whatever...

Forexchampion
forex_champion
 
Posts: 13
Joined: Sun Apr 11, 2010 3:37 pm

Re: Leverage: a tool that should not be taken lightly!

Postby forex_champion » Wed Apr 14, 2010 7:02 pm

I don't remember what I chose at that time. Is there a way to verify what I chose on their platform? Or since it is a demo account, I could open another one and remember the settings lol. :D

Forexchampion
forex_champion
 
Posts: 13
Joined: Sun Apr 11, 2010 3:37 pm

Re: Leverage: a tool that should not be taken lightly!

Postby forex_champion » Wed Apr 14, 2010 7:20 pm

Hey thanks man for your support! I have according to what you told me to do a standard account since every pip seems to represent a 10$ profit/loss in the account.

Now what about leverage?

Forexchampion
forex_champion
 
Posts: 13
Joined: Sun Apr 11, 2010 3:37 pm

Re: Leverage: a tool that should not be taken lightly!

Postby forex_champion » Wed Apr 14, 2010 7:54 pm

Wow you make it so clear now! Thanks again I totally understand what you're saying. But now that is of course if I have a capital of 1000 $. Can we calculate for example with a capital of 5000$. Everything is multiplied by 5 and 2% of 5000$ is 100$. So now money at risk is 100$ right?

But how is leverage useful in all this? In the previous example is the guy with 1000$ using a 1:1 leverage? Therefore the account capital stays at 1000$ right? I know that leverage is a double edged sword since it can make your account bigger in less time, but it could also blow your whole capital from one single trade when not used intelligently. But how would it work is the person with 1000$ like the example you listed wants leverage? Is it possible for him to take a 100:1 ratio with only 1000$? By taking that his account would be 100 000$ but he has a standard account therefore he cannot do this since used margin would 1% of 100 000 = Ultimately leaving the trader with 0 usable margin...

Thanks for keep answering my questions which must seem very irrelevant but believe me you're helping me learn a lot.

Forexchampion
forex_champion
 
Posts: 13
Joined: Sun Apr 11, 2010 3:37 pm

Re: Leverage: a tool that should not be taken lightly!

Postby forex_champion » Wed Apr 14, 2010 9:09 pm

Ok so can you make me an example? How much leverage should someone use if their account had a 5000$ or 2000$ for example? Of what I understand from what you're telling me is that what truly matters is your stop loss. Therefore since for example the person having 5000$ in his/her account, has a risk capital of 2% per trade which is 100$, any trade should never go more than 10 pips against the position right? That is of course neglecting the spread.

Let me start over again. John has 5000$ in his account. The very first thing he has to do before start trading is decide whether or not he wants to have a standard account (10$/pip) or a mini account (1$/pip) with his broker, right? By the way I do not know how to figure out which one is better, I suppose it depends on how much money you have in the account. I hear people saying that for a mini account it is most wise to start with at least 10 000$, and for standard 100 000$ but still why is that? I don't like memorizing things, I would rather take the necessary time to truly understand the nature of the subject and know why things should be done a certain way.

Second of all, once he decides the account (lets say he chose a standard one), to operate with a standard account HE NEEDS 100 000$ right? Since each lot represents 100 000$. Therefore he is obligated to take a leverage from his broker. Now to specify, under John's plan, he has decided that before even entering the market that under any circumstances he will only lose 2% of his total account in case something went in the opposite direction. Consequently, John at each and every trade, would have a maximum risk of 100$. Since he chose to have a standard account, his stop loss represents 10pips and if we subtract 3 pips for spread that leaves him only with a mere 7 pips. How much leverage is needed to operate such an account? Wow I'm getting lost...

Forexchampion
PS: lol not so much of a Forex champion am I?
forex_champion
 
Posts: 13
Joined: Sun Apr 11, 2010 3:37 pm

Re: Leverage: a tool that should not be taken lightly!

Postby forex_champion » Wed Apr 14, 2010 9:38 pm

Thanks man I really appreciate it!

Forexchampion
forex_champion
 
Posts: 13
Joined: Sun Apr 11, 2010 3:37 pm

Re: Leverage: a tool that should not be taken lightly!

Postby forex_champion » Thu Apr 15, 2010 2:35 pm

Ok I think I finally understand the whole thing. Tell me if I'm wrong: Leverage is not something that you can really choose in the sense that there is not like a button where you can say I want 50:1 and now I want 10:1. Leverage is simply something that your broker gives you depending on the lot size chosen. So in reality each trader is free to choose which ever leverage he wants, but this will be determined by the lot size chosen.

For example, a guy has 5000$ and decides to open a mini account. Every pip movement represents 1$ of profit/loss. In his strategy he decides that a stop loss should be placed at the nearest swing high when going short. Lets pretend that he does this and the particular swing high is at a distance of 300 pips. This would mean:

300 pips = 300$
300$ represents 6% of his total capital. Therefore he cannot short one entire lot, he would have to go with 0.33 lot size right?

Later on while still shorting, he decides to do the same for another currency but this time it is 150 pips. This would mean:

150 pips = 150$
150$ represents 3% of his total capital. Therefore he cannot short one entire lot, he would have to go with 0.67 lot size right?

I'm trying to understand the material without depending on the toolbox. If it always calculates everything by itself I would never get the logic behind it.


Ok this is the harder part for me. Calculating the used and usable margin. How is that done?

Thanks again!
Forexchampion
forex_champion
 
Posts: 13
Joined: Sun Apr 11, 2010 3:37 pm

Re: Leverage: a tool that should not be taken lightly!

Postby forex_champion » Thu Apr 15, 2010 8:44 pm

So I should just forget about the specifics (used, usable)? As long as I keep in mind that risk level is a constant (2%-3%) and should never increase from that value no matter what money is in the account. When we think about it, it is truly irrelevant to calculate used and usable margin because what really matters is the risk the trader takes on every trade.

Thanks man, don't know how I would have figured that one out without your help! I'm grateful. If there's ever anything that you feel uncertain about and you ask me, even tough I don't have as much experience as you, I'll try my best to help you!

Best regards,
Forexchampion
forex_champion
 
Posts: 13
Joined: Sun Apr 11, 2010 3:37 pm

Next

Return to Newbie questions & answers



cron