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Leverage 2/2

19 Feb 2018,

In the first part of our article about leverage, we explained in details how we can work with leverage, what are the advantages and disadvantages of the leverage and how the margin is calculated on its bases.

The second part originated primarily from the need to beat the myth many newcomers believe to: leverage 1: 500 is riskier than a 1:50 leverage. That is not entirely true. It depends on the point of view and on how you trade and control your risk.

If you do not trade without any strategy and you are not trying to beat with a single soldier the whole army, the leverage does not play a role at all because you are trading reasonably. That means you are not trying to control with your $ 300 account positions of 100,000 units (1 lot) size, but you are trading small positions proportional to the size of your account.

Yes, in a way, high leverage trading is riskier than low leverage trading, but the most important is your market approach. The biggest enemy of a trader is not the market, but the greed and the will of the trader to earn as much as possible and undertake high risk.

It can be understood based on an example of two types of traders:

trader # 1 has a $ 500 account and a 1:500 leverage, he buys 0.1 lot EURUSD at 1.12340

0.1 EUR / USD lot with 1:50 leverage on a dollar account.

Number of units: 10,000

Required margin: 10,000 / 500 * 1.12340 = $ 22.4

When the market moves by 1 pip, he or she will earn $ 1

Trader # 2 has a $ 500 account and a 1:50 leverage, he buys 0.1 lot, EURUSD at 1.12340

0.1 EUR / USD lot with 1:50 leverage on a dollar account.

Number of units: 10,000

Necessary margin: 10,000 / 50 * 1.12340 = $ 224

When the market moves by 1 pip, he or she will earn $ 1

Point: Profit or loss is not different because both traders have entered to the trade with 0.1 lot, only the margin is different. Regardless of leverage, they risk is equal if they are in the same position.

I have often heard from new traders that higher leverage is more risky. But it’s not. As we have seen above, greed is risky. Let me show it on another example.

 Greedy trader´s risk

Let’s assume that our traders from the example above would like to buy maximum they can to make the most of it.


How much can they buy?

 The first trader has $ 500 and 1:500 leverage, so he can buy a total of $ 250,000 !!!! Which is incredible.

If he buys EURUSD, it will buy according to the formula:

balance / (100,000 / leverage * EURUSD), ie:

500 / (100,000 / 500 * 1,12340) = 2,23 lots.

Why 2.23 lot? The required margin per 1lot is $ 224 and we have a $ 500 account, ie 500: 224 = 2.23 lot

He has:

$ 500 capital

2.23 lot EURUSD purchased

When the market moves by 1 pip he earns or loses $ 22.3!

So, his account lasts about 22.5 pips and it is gone if the market moves against him.

One normal stop loss is enough, and the account is finished.

P.S .: This is a hypothetical example, the actual number of pips will be smaller, depending on the size of your broker’s stop-out, which is the minimum margin that you have to keep in your account and can differ according to the broker.

The second trader has $ 500 and a leverage of 1:50, so he can buy a total of $ 25,000. Still a lot, but it’s better.

If he buys EURUSD, he will buy again according to the formula:

capital / (100,000 / leverage * EURUSD), ie:

500 / (100.000 / 50 * 1.12340) = 0.22 lot.

He has:

$ 500 capital

0.22 lot EURUSD purchased

When the market moves by 1 pip he earns or loses $ 2.22!

So, his account lasts for about 225 pips and it is gone if the market moves against him.

One stop loss is enough and 10% of the account is lost

As you can see, leverage 1:50 is still unnecessarily high and you risk a lot. In both cases, I would compare the trader to a gambler, not to a trader.

The point is that the leverage itself is not risky unless you trade unreasonably high positions. On the next example I will show that we do not really need a 1:50 leverage.

 How big leverage do you really need?

Let’s look at what leverage you really need for a reasonable trading.

Let’s say you have a $ 500 account and 20 pips stop loss. You want to risk 2% of your account, $ 10.

1 pip for one EURUSD lot is $ 10, so you want to risk $ 10 per 20 pips.

Thus, the size of the position will be:

1/20 = 0.05 lot = 0.05 * 100.000 * 1.12340 = $ 5617 position value.

So, for the $ 500 account, you have opened a position for $ 5617 = used leverage of 11.2.

With a smaller stop loss you can of course have a bigger leverage, but I personally do not recommend stop loss of 5 pips and similar.

If we would have a stop loss of 50 pips, then we have a position of 0.02 lot, that is, $ 2246.8 and used leverage 4.5.

As you can see, a leverage of 1:15 is enough for a smart trader. It does not matter whether we have 1:50, 1: 100 or 1: 500, we actually open only a small position and use actual leverage of eg 1:15. The leverage has only an effect on the margin, nothing more.

Suggested leverage limit 1:30 and impact on traders

You may have heard that ESMA, the European regulator of the financial markets, wants to limit the leverage to 1:30.

In my opinion, there is nothing that affects traders. As you can see, leverage 1:15 for most traders is enough, so 1:30 is more than enough.

Maybe you are thinking what if I trade more positions. Here’s a simple idea – if I want to open 5 positions, I certainly will not risk by every position 2%. If all of them end up in a loss, I’ll spend 10% of my account, and that’s a lot. In this case, I lower the position to 1% or less and I can still manage this with leverage 1:30

As you can see, you have nothing to worry about, if you trade and manage the risk correctly, the leverage will not limit you. And if you do not know how to build a strategy where you need a smaller leverage, check the ebook under our article.

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