In this article, you'll discover how to effectively utilize leverage, calculate it accurately, and avoid common beginner errors.
Additionally, you'll gain insight into how leverage is connected to margin and learn which leverage levels are appropriate for your trading activities.
Let's get started!
What is leverage
How much leverage should you use
The relationship between leverage and margin
Leverage allows you to trade with more money than you have.
It enables traders to amplify the impact of a trade by multiplying the invested funds.
In other words, the broker provides loan capital so that you can trade, but requires you to deposit a certain amount as a guarantee to cover potential losses.
For example, to manage a position of $10 000, the broker will allocate $100 of your capital. In this case, the leverage used is 1:100.
Alternatively, it can be stated that each dollar deposited provides 100 times more purchasing power with 1:100 leverage, 200 times more purchasing power with 1:200 leverage, and so on.
The amount the broker requires varies with the level of leverage and is referred to as the margin.
An example further down in the article illustrates the relationship between leverage and margin.
You can learn more about margin in the following article:
>> What is margin in the financial world
Formula for calculating leverage:
Leverage = Trade size / Required margin
For instance, if a margin of 1% is needed for a 1 lot trade on EURUSD, which amounts to EUR 100 000, the required margin would be EUR 1 000.
Here's what that looks like:
Leverage = 100 000 (lot size) / 1 000 (margin required)
Leverage = 1:100
One of the most common questions is what leverage should I trade with?!
Keep reading!
In the Forex market, brokers offer 1:100, 1:200, 1:400, and even 1:1000, which sounds great.
Find out how to begin your trading career
>> Forex Trading: A Complete Guide for Beginners
High leverage can be risky if not used correctly by the trader. The table below shows how varying levels of leverage impact the required margin for an account with EUR 10 000 equity.
Leverage | Possibility to buy/sell 10,000 EUR | Margin in % (Margin requirement) | Margin in EUR for each standard lot |
---|---|---|---|
1:20 | 200,000 EUR (2 standard lots; 20 mini lots) | 5% | 5000 |
1:50 | 500,000 EUR (5 standard lots; 50 mini lots) | 2% | 2000 |
1:100 | 1,000,000 EUR (10 standard lots; 100 mini lots) | 1% | 1000 |
1:200 | 2,000,000 EUR (20 standard lots; 200 mini lots) | 0.5% | 500 |
1:500 | 5,000,000 EUR (40 standard lots; 500 mini lots) | 0.2% | 200 |
Let's look at the following examples:
Example #1
Example #2
As leverage increases, the required margin decreases, making it possible to trade larger volumes without putting excessive strain on the account.
Realistically, it doesn't matter what leverage you use if you have a good money management strategy.
It's more important to know how much you can afford to lose on a trade than to worry about whether your leverage is high.
If you have a small account and use low leverage, you may not have sufficient free margin to execute all the trades you identify. In such cases, opting for a higher leverage might be more effective.
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The higher the leverage, the lower the required margin. However, high leverage doesn't change the pip value.
If you have an account of $10 000 with a leverage of 1:100 and place a full lot trade on EUR/USD, the pip value would be $10 and the required margin would be $1173.8 (at a rate of 1.1738 on EUR/USD).
Having the same $10 000 account and trading a full lot but with a leverage of 1:500 means that the pip value remains $10 but this time the required margin will be five times smaller - $234.7.
Therefore, if your Stop Loss is hit, the loss in both cases would be $1 000.
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Many people believe that high leverage in itself increases the risk of loss, but the example above shows that this is not exactly the case.
It simply provides the opportunity to trade with larger volumes but does not require you to do so.
It became evident that the leverage you use is less important than the loss you set for each trade.
High leverage allows you to fully utilize your account by trading the maximum volume relative to your capital to potentially achieve greater profits. However, this also carries a significant risk of losing your entire account.
This should only be done with small accounts designated for high-risk trading.
The capital for such an account shouldn't affect your living standard or monthly budget if lost.
In conclusion, I will add that everyone should determine the degree of risk on their account.
You can use high leverage wisely and take advantage of it, so don't stress about high leverage. It won't change anything unless you do!