Trading
on leverage
Traders
use leverage on a trade to increase the gain or loss on a trade.
Without using leverage often the exchange rates to that change is not
enough to make trading worthwhile. By amplifying the trading with
leverage, the trader can turn a very small moving exchange rate into
a large profit or loss on the account. A trader with the $10,000
account and he decides to trade 1 mini-lot worth of currency on the
GBP / USD pair. He borrows $10,000 worth of currency and exchanges it
for the British pound. What he has done is he has borrowed $10,000
with their currency with an account balance of $10,000 to start
trading with his own money.
Account Balance
|
$10,000
|
Position Size
|
$10,000
|
Leverage
|
1:1
|
He
is still trading with the broker’s money although the account
balance is the same. So his position size is the same size as the
amount in his account. His leverage is 1:1. Remember that leverage is
always a ratio of the amount of currency the trader's trading in
ratio to the size of his account balance.
Let's
say instead of buying just one mini lot, he had decided to buy 2
mini-lots or perhaps added a second mini lot later. He now holds the
position size of $20,000 worth of currency with his account balance
still being on the $10,000. He has borrowed $20,000 from his broker
and so his leverage is down 2:1 because he has a position size twice
as much currency as the balance in his account.
Account Balance
|
$10,000
|
Position Size
|
$20,000
|
Leverage
|
2:1
|
Instead
of just buying one or two lots the trader decided to borrow a lot of
currency to try to capitalize on a very small move in exchange rate
in a very short period of time. So what the trader does instead this
time is he borrows $100,000 worth of currency. His account size is
still $10,000 and he borrowed $100,000, so his leverage is 10:1. He
holds the position size is 10 times as big as the size of his
account.
Account Balance
|
$10,000
|
Position Size
|
$100,000
|
Leverage
|
10:1
|
Leverage is always the total position size, of all positions versus
the account balance. Let's say the trader buy on one mini-lot of a
currency, like for instance the euro dollar pair and 2 lots on
another currency pair, for instance the dollar-yen pair. They would
have still have a total position size of $30,000 a three mini-lots
versus a $10,000 account so they leverage would be 3 to 1.
Account Balance
|
$10,000
|
Position Size
|
$30,000
|
Leverage
|
3:1
|
On
a standard trading account most brokers will offer 100:1 leverage,
meaning to allow you to borrow 100 times your account balance and
trade it. With a $10,000 account you can trade up to a million
dollars for the currency. On a micro account, most brokers will offer
400:1 leverage meaning to allow you to 400 times your account balance
of trade with that. Usually new traders who hear this immediately
think of large rewards but one must remember that leverage is a two
way road. Larger position sizes can amplify gains but they can also
amplify the losses. Large position size is the number one reason new
traders lose money.
Leverage
can exponentially increase your profits as well as your losses so it
is crucial that traders take care when using leverage. The larger
your position size, the larger your pip value will be and therefore,
the greater the impact on your profit and loss (PNL)..
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