This week’s question comes from Roberto, who asks:
How much leverage should I use when trading Forex?
The topic of leverage in the Forex market tends to cause a lot of confusion.
What is it and how does it work? Are there advantages or disadvantages?
Unfortunately, the answers to these questions often go unanswered. It’s unfortunate because using excessive leverage is one of the leading killers of Forex accounts.
In fact, I would argue that it belongs at the top of that list.
The good news is that you found this post. By the time you finish today’s lesson, you will know what leverage is and how it works. You’ll also have a firm understanding of how much you should use when trading currencies.
I’m even going to share with you a simple way to make the risk of using too much leverage a non-issue.
Let’s get started.
What is Forex Leverage?
Leverage in the Forex market allows you to control a larger sum than you’ve deposited initially.
Let’s say you put up $1,000. Here in the U.S., the maximum leverage is 50:1. That means you can actually control $50,000 of tradable equity.
Of course, you can’t withdraw that extra $49,000 (wouldn’t that be easy?), but it is there for you to put on positions.
We know that a $100,000 position is equivalent to one standard lot. That means $10,000 is one mini lot and $1,000 is a micro lot.
So if you were to open a $10,000 position (one mini lot) with your $1,000 account, you would be using 10:1 leverage. For every $1 you put up, your broker is allowing you to borrow $10.
Simple enough, right?
I could get into all kinds of scenarios and equations here, but I like to keep things simple. The above example is really all you need to know about leverage in the Forex market.
It also wouldn’t do you much good because as you’re about to see, leverage isn’t much of a factor as long as you manage one very important thing. But more on that later.
For those who want to dig deeper, check out these examples.
Use the Least Amount or None at All
Did you know that you can set the leverage available to you?
Yes, you can actually control how much your Forex broker allows you to borrow. Most brokers start new clients with 100:1 leverage. That’s usually the go-to figure (unless you’re in the U.S. where leverage is capped at 50:1).
However, if you aren’t comfortable with that, you can reduce it to your liking.
Most trading platforms will allow you to do this without having to get your broker’s support. Of course, if you don’t see the option, you can always request that they lower it for you.
What’s the best setting, you ask?
There isn’t one. It depends on your circumstances and trading style.
That said, I would opt for the lowest amount possible or none at all. The latter is particularly easy for those with larger accounts.
Chances are you will need to use some leverage. Otherwise, the potential profits may not be worth your time.
You also don’t want to set it so low that you run the risk of a margin call. If you’re unsure about this, be sure to speak with your broker.
And if you’re looking for a Forex broker with excellent customer service and New York close charts, check out Blueberry Markets.
But even if you have a smaller account, you don’t need 400:1 or even 100:1 leverage. And if you do, it’s a sign that you’re probably risking too much per trade.
As a new or struggling trader, limiting your leverage to 20:1 or even 10:1 is a wise decision.
Unless you’re consistently profitable, using high levels of leverage will only help deplete your funds that much faster.
Remember, the name of the game is to survive. You do that by protecting your capital, and limiting the leverage available to you is a good place to start.
Focus on the Amount Risked Instead
Now that you know what leverage is and that it’s a double-edged sword, I’m going to tell you to forget about it because it’s a non-issue.
Allow me to explain…
As long as you manage your risk per trade, the amount of leverage available to you is insignificant. It simply doesn’t matter.
I could offer you a trading account with 10,000:1 leverage so that for every $1,000 you put up, I’m allowing you to control $10 million.
Sounds crazy, right?
But as long as you risk just 1% or 2% of your account balance, it makes no difference.
Two percent of $1,000 is $20 regardless of the leverage available.
The key word there is ‘available’. As long as you don’t abuse it, leverage can’t hurt you. Where traders get into trouble is when they start risking half of their account, or worse, on a single trade.
Using the example above, if your stop loss was 50 pips from your entry, you would use a 4 micro lot position, or $4,000. That means you’re only using 4:1 leverage.
Need a Forex position size calculator? Click Here
I’m still a fan of asking your broker to reduce the leverage available to you. If nothing else, it will deter you from making the mistake of overleveraging your account.
But at the end of the day, the amount of capital you risk per trade is far more important. As long as you keep it reasonable (between 1% and 3% in my opinion), the amount of leverage available to you is mostly irrelevant.
Leverage is a double-edged sword. On the one hand, it can help to boost profits, but it can also exacerbate losses.
In my opinion, the best leverage is none at all or the least amount possible. This is particularly true if you’re losing money on a consistent basis. Using excessive leverage when you’re losing will only deplete your trading account that much faster.
Many traders don’t realize that they can control the leverage available to them. If you’re just starting out or still struggling, you may want to set it as low as possible. It will help keep you in the game by preventing you from trading too large.
While the amount of leverage you use is important, it isn’t everything. In fact, it’s somewhat trivial.
As long as you keep your risk to just one to three percent of your account balance, the leverage available to you is rather insignificant. After all, one percent of $1,000 is the same regardless of whether your leverage is 50:1 or 400:1.
Your Turn: Ask Justin Anything
I’d love for this new weekly Q&A to be successful and provide an invaluable repository of answers to common Forex questions.
To do that, I need your help.
Here’s what you can do to get involved and have your question answered in next week’s post:
- Ask questions. Post them in the comments below or Tweet them to me @JustinBennettFX
- Help me answer questions. If I missed something or if you have something to add, don’t hesitate to leave a comment below.