Leverage offers traders a lot of advantages and opportunities. If you know how to use it well, it might give you hefty profits to bring home. For instance, a 100:1 leverage ratio is like being able to open a $100 position with only $1 from your account and then borrowing the rest, which is $99. Hence, you can control a $100k position even if you only have $1k in your account. You can get as much as $100k profit if you win the trade. However, leverage has its share of disadvantages. The trade can always move in the direction against your favor. So, inasmuch as leverage excites you about the profits it can give you, you should be a hundred percent sure about the ins and outs of leverage trading.
Price movements and leverages
Let us look at how much a 1% currency change can impact your account balance in line with the leverage used.
- 100: 1 leverage — 100%
- 50: 1 leverage — 50%
- 33: 1 leverage — 33%
- 20: 1 leverage — 20%
- 10: 1 leverage — 10%
- 5: 1 leverage — 5%
- 3: 1 leverage — 3%
- 1: 1 leverage — 1%
Let us assume that you bought a EUR/ USD currency pair, and it increased by 1%. You decided to trade a $100k standard lot. That 1% change in your currency pair would significantly impact your account depending on the leverage ratio you are in:
- 100: 1 leverage & $1k margin requirement =+100% account change
- 50: 1 leverage & $2k margin requirement = +50% account change
- 33: 1 leverage & $3k margin requirement = +33% account change
- 20: 1 leverage & $5k margin requirement = +20% account change
- 10: 1 leverage & $10k margin requirement = +10% account change
- 5: 1 leverage & $20k margin requirement = +5% account change
- 3: 1 leverage & $33k margin requirement = +3% account change
- 1: 1 leverage & $100k margin requirement = +1% account change
Suppose the EUR/ USD currency pair decline by one percent, the margin requirement of every leverage ratio and the change in the account will be the same. The only difference is that instead of a positive account change, it will be a negative one. Hence, leverage is a double-edged sword.
More leverage or less leverage?
The more leverage you have, the fewer chances you give the market to move before a margin call happens. Most traders with experience that became successful do not use a lot of leverage. They would mostly be around a 3:1 leverage ratio, and their maximum would be a 5:1. This goes to show that leverage is not only the solution. Experienced traders know that to succeed, proper and decent capital is essential.
The capital is crucial.
If you researched well enough before trading, you should know that proper capitalization should also be significantly considered to be successful. Do this so that all of the things you did, like the market analyses, trading system, journal, and plan, will not waste just because you did not have enough capital. Save up and pair that with smart leverage. If you are a new trader, know that the lower the leverage ratio you use, the better. Use 10:1 as your maximum, but 1:1 would be for the best.