Learning

Jul 4

# Big leverage – is it good or bad?

There is no consensus about what leverage is optimal for trading. Many traders tend to keep leverage as small as possible because it prevents them from opening many positions or positions of large volume. Other traders (mainly beginners) consider that leverage significantly increases traders’ risks.

## Let’s briefly understand the word leverage.

Leverage on the Forex market – is the ratio of the amount of borrowed capital of the broker to the number of funds operated by the trader. In other words, the trader can enter into transactions for amounts much greater than the trader’s deposit.

## Let’s look at an example:

Trading on Forex is made in the form of standard lots. One lot is equivalent to 100,000 units of the base currency. So, if a trader trades the US dollar (USD), opening position in 1 standard lot, he is buying/selling 100,000 units of this currency. Accordingly, to work with 0.1 lot, we have 10 000 base units (100 000 × 0.1), and 0.01 lot = 1 000 base units (100 000 × 0.01).

Assume that the trader has \$200 on deposit. The leverage on the trading account is equal to 1:200. It means that the trader can work with an amount 200 times the size of their deposit, i.e., \$40,000. Let’s assume a trader opens a position with 0.02 lots (2,000 units of the base currency) on the EUR/USD currency pair. In this pair, the base currency is EUR. Thus, the margin level for this position is 2000 EUR/200 = 10 EUR. Since the trader’s deposit is expressed in USD, the 10 EUR will be converted according to the rate at the position opening. If the EUR/USD exchange rate at the moment of position opening was, for example, 1.0050, the margin level would be 10 × 1.0050 = 10.05 USD.

## Does leverage affect risk?

Let’s compare two accounts: one has 1:50 leverage, and the other has 1:500 leverage. On both accounts, the trader has opened a position with a volume of 0.1 lots (10,000 units of the base currency). And the trader has lost 100 pips in both accounts. On which account will the loss be greater? Answer: the loss will be the same in both accounts.

The leverage only affects the margin. The more leverage you have, the less margin you will need to open a position, and vice versa. The less leverage you have, the more margin you will need to open a position.

This is why phrases like “big leverage is risky” or “big leverage will help you quickly lose deposit” have no proof. Leverage allows you to open more positions, but the decision to increase the risk is up to the trader, not the leverage.

Remember, if a trader is using smart money management and knows how to control the risks, the amount of leverage does not affect the trader’s results. If a trader does not know how to deal with the risks adequately, he loses his trading account quickly, both with 1:10 Leverage and 1:1000 Leverage.

Some brokers offer traders floating leverage. What is floating leverage? This leverage varies automatically, depending on the total volume of traders’ trading positions. As trading volume increases, such leverage will decrease. There is some logic here. The more deposit the trader has, the less leverage he needs.