See how much leverage you need for your trading style. Leverage has pros and cons, so we want to utilize it effectively but not recklessly.
How much forex leverage to use is a common question, especially among new forex traders. And it is little wonder why, as some forex brokers are offering up to 500:1 leverage. That means the possibility of taking positions which are up to 500x larger than the capital that is in the account!
Forex Leverage Explained
Leverage is essentially using borrowed money to trade. In the forex market, most brokers provide leverage with few strings attached, but there are a couple things to be aware of.
Most brokers will allow you to purchase a greater amount of currency than you have in your account. For example, you may have $1,000 in your account, but you can buy $5,000 worth of the EUR/USD. On this trade, you are leveraged 5:1. The broker doesn’t charge a fee for this luxury, but they are still making money in different ways. In the forex market, the larger your position size the more the broker makes/charges on commissions. This is a bit different than the stock market where many brokers charge a flat commission regardless of how big or small the position is.
While the broker doesn’t charge interest, the market does. Currency traders are subject to the interest rates prevailing in the currency they trade. For example, if you buy a currency with a higher interest rate and sell the lower interest rate currency, you will receive a credit in your account each night for the interest rate difference.
If you buy a lower interest rate currency and sell a higher one, you will be debited the interest each night. Every transaction is the simultaneous buying of one currency and the selling of another. Therefore, on any trade that is held overnight, that position will see a credit or debit (assuming an interest difference) applied to the traders account each night. For a more detailed look at rollover, see Rollover in the Forex Market.
Most traders realize that leverage is a double-edged sword, magnifying profits as well as losses. To understand how much forex leverage to use we will look at examples using different account sizes and trading styles.
Money Management and Leverage
Before discussing leverage, we need to discuss risk management, because the two concepts are linked.
For instance, assume you buy the EURUSD at 1.30. You place a stop loss at 1.29, which is 100 pips lower than the entry price. In the EURUSD, each pip is worth $10 on a standard lot (100,000 worth of currency), $1 for a mini lot (10,000), and $0.10 for a micro lot (1,000). Therefore, the risk of the trade for one standard lot is $1000 (100 pips X $10 per pip), $100 for a mini lot, and $10 for a micro lot. If multiple lots are taken then the dollars at risk for one lot would be multiplied by the number of lots taken. If you are unclear on what pips are, and how they are valued, read Calculating Pip Value.
The dollar amount at risk should not exceed 1% of deposited capital. So in the case above, if taking a trade where the risk is $1000, the account size must be at least $100,000. If risking $100 per trade, the account size should be at least $10,000, and if risking $10 per trade, the account size should be at least $1000 (because $10 is 1% of $1000).
With some management guidelines under our belt, we can begin to consider how much leverage we should use/need for our account size and trading style.
Scenarios for How Much Forex Leverage to Use
The easiest way to discuss leverage is to look at some examples of how much leverage is needed based on different combinations of account size and trading style.
Swing Trading a $10,000 Account
Based on the account size of $10,000, the trader can risk $100/trade (1% of 10,000). If a trade develops which has a 300 pip risk (difference between entry and stop loss), the trader can take 3 micro lots, which results in a $90 risk. In this case, no leverage is needed. Taking a trade such as this means $3000 (3 micro lots) is deployed and the account more than covers such a transaction.
If a trade arises with a 75 pip stop loss, they can still risk up to $100. In this case, they can take 1 mini lot ($75 at risk) and 3 micro lots ($22.5 at risk). If they take 1.3 mini lots total, their risk is $97.5, which is just below the $100 risk limit.
1.3 mini lots is $13,000 worth of currency, and they only have $10,000 in their account. At least 2:1 leverage is recommended in this case, as that will give them the ability the to trade 20,000 in currency (2 x $10,000), which is more than enough to take this $13,000 position.
If multiple positions are taken at the same time the trader will need to utilize more leverage, such as 5:1 or 10:1. Each trade could have a different stop loss, so it is better to have slightly more leverage than not enough. If you have extra leverage, you don’t need to use it.
Day Trading a $10,000 Account
Since a pair like EURUSD usually moves between 90 and 130 pips a day, day traders will likely not be risking more than 10 to 20 pips on a trade. Losses on individual trades should still be kept to 1%, or less, of the account value. Taking a trade with 20 pips of risk means the trader can take 50 micro lots or 5 mini lots, which would equate to a risk of $100 in the EURUSD.
5 mini lots is $50,000 worth of currency, so some leverage is needed (only $10,000 in the account). Risk is well controlled, so in this case, leverage is a great advantage for this strategy. If the trader had 2 positions it would mean $100,000 is deployed in the market. Therefore, this trader would need a minimum of 10:1 leverage, but could even go up to 20:1 (allows the trader to deploy positions worth up to $200,000) or 50:1. Beyond that, there is little use for more leverage.
The same concept applies to larger or smaller accounts.
If you only have a $1000 account and want to day trade, you will likely also want to use about 20 or 30:1 leverage. Everything is the same as above, except you will be risking $10 per trade and your position sizes will be 1/10 of those discussed above.
Many day traders also swing trade. If you do this, consider your day trading leverage requirements, as well as your swing trading leverage requirements. Making sure you have enough leverage to accommodate both styles of trading, which means potentially have several swing trades deployed while also day trading at the same time.
Scalping a $5,000 Account
Sticking to not risking more than 1% of deposited capital, this trader can risk up to $50/trade (1% of $5,000).
Scalpers usually risk a small amount (in terms of pips) on each trade. Let’s assume the trader risks 10 pips on a trade. That means in the EURUSD they can take 5 mini lots. If 10 pips is lost on 5 mini lots they have lost $50 or 1% of the account.
5 mini lots cost $50,000, so leverage of 10:1 is required to take this trade. It is also possible that multiple trades may be in effect at one time. If three positions are held at a time, that means up to $150,000 in positions may be deployed. That requires at least a 30:1 leverage. For a bit of extra room use 50:1, but that is only if you are holding multiple positions at one time. If you typically take one day trade at a time (like I do), then in a case like this, about 15 or 20:1 leverage is fine.
Risking 5 pips would mean a position size of up to 10 mini lots or 1 standard lot. This would require 20:1 leverage.
Why Do Brokers Provide Such Huge Leverage?
If you are wondering why forex brokers offer leverage of up to 500:1, the answer is simple. It entices traders to invest $100 (or so) and try to gamble their way to profits. A micro lot costs $1000 in a pair such as the EURUSD, so opening an account for less than $1000 means the trader needs leverage just to buy the smallest position size available. And since most new traders come to forex market with illusions of grandeur, it is likely they will risk far more than 1% of their account, and leverage provides a way to do that. Insanely high leverage allows people to swing for the fences in the hopes of a hitting a couple big winners, but it rarely happens. The broker will happily take the commissions from all these small accounts.
Control risk on every trade using a stop loss. Leverage is good, but can also be devastating if used incorrectly. With leverage, it is possible to lose more money than what is in the account, resulting in a debt to the broker. There are ways to reduce the risk of catastrophic loss, but the risks can never be totally eliminated.
Final Word on Forex Leverage
Using the examples above you can calculate how much leverage is needed for your account size and usual trading style. Many traders may find they actually don’t even need leverage, but having some is fine. You can have leverage on the account, but don’t have to use it if it isn’t required.
For most traders out there, 50:1 leverage is way more than enough. 20:1 or even 10:1 will suit most day traders and swing traders just fine.
There are significant risks in forex trading. Using excessive leverage can mean taking a large loss or even wiping out the entire account. Use it with care, and always respect the market.
By Cory Mitchell, CMT
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