True Leverage in Forex Trading conducted by professional Forex trading experts the “ForexSQ” FX trading team, Finding out everything you need to know about what is True Leverage in currency trading.
What Is True Leverage in Forex Trading?
Before you read about “what is True Leverage” lets finding out what is the best leverage per each currency pair.
The first listed currency in a pair is the base currency, and the second is the quoted currency, e.g. in GBPUSD, GBP is the base currency, and USD the quoted currency.
The rate quoted is how many units of the quoted currency can be bought with one unit of the base currency, e.g. if GBPUSD = 1.9029, then USD 1.9029 can be bought with 1 GBP.
Hence, when you enter a long position (perform a buy transaction), you are buying the base currency by selling the quoted currency. A short position (sell transaction) is the reverse.
You buy at the ASK price, and SELL at the BID price (see the “Risk and spread” section below for more info).
1 lot = USD100,000 contract for any xxxUSD pair. 1 pip = 0.0001 dollars (i.e. 0.01 cents) movement. Hence each pip moved results in a gain or a loss of 100,000 x 0.0001 = USD 10.00
For a USDxxx pair, e.g. USDCHF. 1 lot = CHF100,000 contract size, so each pip moved results in a gain or a loss of 100,000 x 0.0001 = CHF 10.00
But if your account is denominated in USD, and the current rate for USDCHF = 1.1335, then each pip moved results in a gain or a loss of 10.00 / 1.1335 =
~ USD 8.22
The exceptions are JPY pairs, where 1 pip = 0.01
So for USDJPY, 1 lot = JPY 100,000 contract size, so each pip moved results in a gain or a loss of 100,000 x 0.01 = JPY 1,000
But if your account is denominated in USD, and the current rate for USDJPY = 100.56, then each pip moved results in a gain or a loss of 1,000 / 100.56 =
~ USD 9.94
Non-USD pairs, i.e. xxxyyy (where neither xxx nor yyy is USD)
1 lot = 100,000 yyy. So if each pip is 0.0001, then it results in a gain/loss of 100,000 x 0.0001 = 10 yyy.
If your account is denominated in USD, and the exchange rate for USDyyy is currently 1.2000, then 10 yyy = 10 / 1.2000 = ~ USD 8.33
Think through the above step-by-step, until you understand it. It’s logically consistent.
Then we can move on to RISK.
How much risk per trade?
There are two factors that determine RISK:
(1) How many pips your stoploss is away from the entry point
(2) How many lots you buy/sell
Let’s say that you have $10,000 trading capital.
The experts say that you should risk only 1%-2% of it in each trade.
So 2% of $10,000 = 0.02 x $10,000 = $200.
Now let’s say I want to buy GBPUSD (1 lot = $10 per pip, see section above)
The question is: how many lots can I buy, to keep my risk at $200, and if I want to set my stoploss just outside a swing point, which happens to be 40 pips away from entry?
Answer: if I trade 1 lot, then 40 pips x $10 per pip = $400 risk.
So to keep the risk at $200, I must trade half of this, i.e. 0.5 lots.
Now, 0.5 lots = 5 minilots = 50 microlots = 500 nanolots, you can work on whatever basis you like.
So the formula is: number of lots = [trading capital] x [percent to risk]/100 / [pips between entry and stoploss] / [dollars per pip]
Let’s do another example using the formula:
— Trading capital = $500
— Percent to risk per trade = 2% (= $10)
— This time you want to place your stoploss is 100 pips from entry
— We’re trading EURUSD, which is $10 per pip (per lot traded)
So the answer is: 500 x 2/100 / 100 / 10 = 0.01 lots (or 1 microlot)
Working backwards to check: at 0.01 lots, the movement is 10 cents per pip. So if we lose 100 pips (from entry to stoploss), the loss is 100 pips x 10 cents = $10, which is 2% of our $500 account.
Here are two very important points:
1. Leverage (explained in the next section) and risk are unrelated, except that leverage determines the maximum amount of risk you can take. But by keeping your risk at 1%-2%, you should never come near to using up your available ‘margin’.
2. In the examples above, it doesn’t matter whether your broker is offering (for example) 50:1, 100:1 or 200:1 leverage. Your risk is still $200 in the first example, and $10 in the second example. The leverage is irrelevant.
So the key is: focus on keeping the risk low, and you don’t have to worry about leverage, it will take care of itself.
True Leverage and margin
The margin requirement reflects how much ‘spare’ money you need to have in your trading account, in order to make a trade. By spare money, I mean money that’s not ‘tied up’ in other currently open trades.
Leverage and margin work inversely with each other, thus:
— If the broker offers 10:1 leverage, then the margin requirement is 10% (or, alternatively, it means that you can trade a USD 100,000 contract for every USD 10,000 in your account)
— If the broker offers 50:1 leverage, then the margin requirement is 2% (or trade a USD 100,000 contract for every USD 2,000)
— If the broker offers 100:1 leverage, then the margin requirement is 1% (or trade a USD 100,000 contract for every USD 1,000)
— If the broker offers 200:1 leverage, then the margin requirement is 0.5% (or trade a USD 100,000 contract for every USD 500)
— If the broker offers 400:1 leverage, then the margin requirement is 0.25% (or trade a USD 100,000 contract for every USD 250)
and so on.
So the formula is: margin = 100 / leverage
Example – for xxxUSD pair
Let’s suppose that:
— you want to buy or sell GBPUSD, which is currently priced at $1.90
— you currently have $10,000 in your trading account
— your allowable risk per trade = 2% (= $200)
— your stoploss is 40 pips away from entry
— your broker is offering you 100:1 leverage
Calculate your risk, as explained in the previous section:
Position size = 10,000 x 2/100 / 40 / 10 = 0.5 lots
The margin requirement for xxxUSD is given by the formula = [#lots] x 100,000 / [leverage] x [exchange rate]
Then the margin you need is 0.5 lots x $100,000 per lot / 100 leverage x 1.90 = $950, which is 9.5% of your $10,000.
That leaves 100 – 9.5 = 90.5% of your account, i.e. $9,050, available for use in other trades.
If the leverage was only 50:1, then the amount required would be 0.5 x 100,000 / 50 x 1.90 = $1,900, or 19%, i.e. at 50:1 you need twice the margin, compared to 100:1, and so on.
So at 50:1 you are “tying up” 19% of your account balance, leaving the remaining 81% free (“unused or available margin”) to place on other trades.
As you can see, trading at 2% risk leaves plenty of money (available margin) in the account, so leverage isn’t really a major consideration. And note that the risk is always $200, no matter what the leverage is. If the trade hits the stoploss, you will lose $200, no more, no less.
Example – for USDxxx pair
Let’s suppose that:
— you want to buy or sell USDJPY, which is currently priced at 115.18
— you currently have $20,000 in your trading account
— your allowable risk per trade = 2% (= $400)
— your stoploss is 25 pips away from entry
— your broker is offering you 100:1 leverage, and smallest denomination allowable is a microlot
Calculate the dollars per pip, for each lot:
= 100,000 x 0.01 / 115.18 = ~ $8.68
Calculate your risk, as explained in the previous section:
Position size = 20,000 x 2/100 / 25 / 8.68 = 1.8433 lots
But broker allows only microlots, so round down to 1.84 lots
The margin requirement for USDxxx is given by the formula = [#lots] x 100,000 / [leverage]
In this case = 1.84 x 100,000 / 100 = USD 1,840.00, or 9.2% of the $20,000 account. Hence unused margin = $18,160.00 or 90.8%.
Forex Trading True Leverage Conclusion
Now you know all about what is True Leverage in forex trading, For more information about currency trading brokers visit TopForexBrokers.com forex brokers comparison website, Tip ForexSQ.com foreign exchange trading experts please by share this article about True Leverage.