Forex Leverage Explained, and How Much to Use – TheStreet
A common question is how much leverage to accept from a broker, with some offering up to 500:1. That means you can initiate a position valued at 500 times your capital. That could be profitable, or it could wipe out your capital if the price moves 0.2% against you.
We aren’t going to use that much leverage, we are going to find a balance where we can still make money, but we aren’t as exposed to catastrophe.
Here’s how to figure it all out.
Forex leverage is when a broker provides you with more capital to trade with than what you deposited. This increases your “buying power” and allows you to make trades using this larger amount of capital.
Leverage means you amass profits more quickly than if you just used your own capital. Losses also happen more quickly.
In this article, we will look at how leverage works, why forex brokers offer such higher leverage amounts, and how much to take and use.
How Forex Leverage Works
When you check out forex brokers, or open a forex account, you will be asked (or see) how much leverage you are being offered.
How much leverage you have available to you doesn’t really matter. You decide how much you actually use via your actual trading.
Leverage is how large of a position(s) you can take in relation to your capital.
Assume a broker offers you 100:1 leverage. You have $1,000 in your account. Multiply your capital by your leverage to get your “buying power”. You can take $100,000 worth of positions (100 x $1,000).
If you have 50:1 leverage, you have $50,000 in buying power.
Just because you have this much buying power/leverage doesn’t mean you need to use it.
Assuming you have a $500 deposit and 200:1 leverage. This gives you $100,000 in buying power. That’s a lot on a $500 account. So even though you are able to trade up to 100K of currency, maybe you decide to cap yourself at $15,000, or about 30:1 leverage. You do this by taking position sizes that don’t total more than 15,000 (in your account currency).
Leverage and Margin
You may see leverage listed or advertised another way, as margin.
Some brokers may say they offer leverage up to 50:1. Others may say 2% margin. This is the same thing. The latter means you only need to put up 2% of your own capital against a trade.
If you have $1,000 and 50:1 leverage, you have $50,000 in buying power.
If you have $1,000 and 2% margin, you only need to put 2% for a $10,000 trade (for example), which is $200. That means you take up to 5 such positions in order to “spend” your whole $1,000 account. In this case, you are also taking positions up to $50,000.
Remember, you don’t need to actually use all the leverage or margin available to you! regardless of how much leverage you are offered or choose to take, you can opt to use less leverage based on how you trade. And you should!
Leveraged Profits and Losses
So leverage gives you buying power. By extension, that leverage can increase your profits and losses.
Let’s look at a couple of examples.
Assume you deposit $100 into an account and have 100:1 leverage. You can have positions totaling up to $10,000 worth of currency. That’s maximum; you can have positions totaling less if you want.
Say you like a trade in the EURUSD. You are going to buy at 1.1320 and place a stop loss at 1.13. Your risk is 20 pips. Assuming you have a US dollar account, each pip of movement is worth $0.10 on 1,000 worth of currency (a micro lot). A micro lot is the smallest amount of currency you can trade with most brokers.
Note that you have $100, yet the smallest position you can take is 1,000. This means you are already using 10:1 leverage just by trading the smallest positions size.
You buy one micro lot, which means you are risking 20 pips x $0.10 = $2 of your $100.
That is good. You are using 10:1 leverage, but your risk is controlled with a stop loss order. Your risk is $2, or 2% of your $100 account. 1% or less is better, but 2% is manageable.
Assume you take a profit at 1.3270, which is a 50 pip gain. That means you made $5 (50 pips x $0.10) on your $100 account, or 5%.
That’s amazing, considering that without leverage this trader would not have been able to place a currency trade because they didn’t have enough capital to buy even the smallest amount of currency available.
Let’s consider a reckless trader. They just want to use their leverage to make some quick money.
They deposit $1,000 and have 100:1 leverage. They buy the EURUSD at 1.1320, but they don’t place a stop loss. They think the EURUSD is going up, so they are willing to hold the trade until that happens (scary!).
They buy 100,000 worth of currency. With that much currency, a pip of movement is worth $10. If the price drops to 1.1220, which is 100 pips away, this trader’s $1,000 will be entirely lost (100 pips x $10 a pip). At the time of writing, the EURUSD is moving a bit less 100 pips a day, and most of that movement occurs within about a 10 hour period. So in about 10 hours, this trader could lose their entire account most days, if trading this way.
On this flip side, if the price rises 100 pips, they make $1,000 (100 pips x $10). They doubled their account.
Brokers Offer Huge Leverage To Entice You
Currencies don’t move like stocks. You will often hear stock swing traders talk about prices moving 20%, 40%, 100% within a few days or weeks of a cup and handle breakout, for example.
Currencies tend to move 1% or less a day, and a 30% move over the course of a year would be a large move.
That is one of the reasons that forex brokers offer high leverage. The high leverage allows traders to capitalize on smaller price moves using larger amounts of capital.
There is also another reason. Forex brokers often target clients with small amounts of capital. They do this by offering high leverage and giving traders with less than several thousand dollars the ability to trade. You can’t trade $100 in any other market effectively, but with leverage in the forex market, you can.
Forex brokers know these small accounts will use the leverage. The small accounts will then pay commissions and spreads on the bigger amounts being traded. The broker makes money off all these small accounts.
Most of these small traders won’t last very long, but there is always someone else with $500 or $100 (or maybe even less) willing to give forex trading a try. Small accounts, enticed in by leverage and the chance for profits, are a steady steady stream of revenue for the brokers. Such clients are easily replaceable since there is an endless supply.
Without leverage, those small accounts couldn’t even place a single trade, and the broker’s revenue stream dries up.
How Much Forex Leverage Should You Use
As mentioned, it doesn’t really matter how much leverage you have available to you, because you can always use less.
If you plan to have multiple trades at one time, or you want to day trade, I would opt to take 50:1 leverage.
50:1 should serve most traders just fine.
If you are a day trader, you will likely use quite a bit of leverage for each trade. Assume you have a 5 pip stop loss and risk 1% of your capital on each trade. On a $1,000 account, that means you can lose up to $10. That means you can take a 2 mini lot position (20,000). If you lose 5 pips on 2 mini lots, you will have lost $10, which is the maximum you have allocated for that trade.
Buying two mini lots means you are leveraged 20:1 on that one trade.
That still leaves lots of room for another day trade, at the same time, or for a few swing trades.
Swing trades typically require less leverage because the stop loss is often bigger.
Assume you deposit $1000, risk 1% ($10 per trade), and take a trade in the EURUSD with a 30 pips stop loss. You can buy 3 micro lots (3 x $0.10 x 30 pips), which will mean you will lose $9 if your stop loss is hit. On this trade, you are using 3:1 leverage. You could have many trades like this using 50:1 leverage.
Or, you could have a day trade as well as multiple swing trades.
The smaller your stop loss is, and the higher amount you are willing to risk on each trade, the more leverage you will be using.
Forex Leverage Final Word
If the position sizes and the pip values didn’t make sense to you, read the position sizing article.
I would cap leverage at 50:1. That is the legal limit in the US, and there is little reason to take more. You can make a lot of money using a little bit of leverage in the forex market. 50:1 gives you more than enough leverage to swing trade and have a day trade or two at the same time. I rarely, if ever use that much leverage even with multiple trades on at the same time.
As you consider leverage and opening an account, I would also advise NOT to take the deposit bonus that many brokers offer. This can seriously complicate withdrawals down the road.
In this article, I used pip values for a US account and only used the EURUSD for simplicity. If you have another account currency, or you have a US account but trade currency pairs that don’t have the USD listed second (USD/JPY, for example) then the pips values will be different. Be sure to understand position sizing and pip values for all the different pairs that you opt to trade.
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