Understanding Leverage Part I
Leverage is not even a two-edged sword, it is a guillotine and your head on the block PART 1
Dr Forex says: "Let me explain once and for all that leverage is not what brokers can use it whatever you decide to use ".
Dr Forex says: "Let me explain once and for all that leverage is not what brokers can use it whatever you decide to use ".
At last I am at the point where my Bird Watching in Lion Country Newsletter is ready for publication. If you have not received one before, do not start searching for your e-mail spam filtering. This is the first newsletter.
Choice of subject is a difficult matter, but "change" was always high on the priority list for the first issue. Recently I also realized how misunderstood it is clear that a fundamental part of all aspects of forex. In my view there is no doubt that most of the trouble that forex traders begin to leverage.
I dedicate this first newsletter, to this concept of leverage and destructive force in the retail forex trading world.
A few facts
• Personally, I have not seen an operating account that was not eradicated leveraging high.
• I have no report of sustained profitable trading account based on high-leveraged, short-stop trading.
• I ask my clients mentoring asked what they believe are the reasons for the earlier losses. Most responses also something to do with leverage, not understanding at all, or only partially, or underestimate it if they once understood.
Leverage then ...?
I get many questions, including those below
I am reading your book and I'm really enjoying. Can you give me the information I can get 1:1 leverage with the company on page 108 of your book called? I use a demo with only $ 1500 on the account with 200:1 leverage and I'm a little worried about this even on 1 mini contract with one currency.
Or:
I contacted the broker you suggested where I could trade with less than $ 10,000 with a low leverage, but they only offer 50:1 leverage and not 3:1 as you suggest.
I get many questions, including those below
I am reading your book and I'm really enjoying. Can you give me the information I can get 1:1 leverage with the company on page 108 of your book called? I use a demo with only $ 1500 on the account with 200:1 leverage and I'm a little worried about this even on 1 mini contract with one currency.
Or:
I contacted the broker you suggested where I could trade with less than $ 10,000 with a low leverage, but they only offer 50:1 leverage and not 3:1 as you suggest.
It is very clear that leverage is misunderstood and this misunderstanding is a cause of the forex trading losses and the futile attempts to overcome these losses without addressing the cause.
Regulatory warnings that leverage is a two-edged sword that can work for or against you go completely ignored, just as the warning "past performance is no guarantee of future 'is flatly ignored.
Leverage is largely misunderstood, because the marketing wizards of forex (your friendly forex broker) have made a slight-of-hand trick that the attention of the very important fact of how many traders are shifting levers on how the capital market forex trading wizard the trader is willing to Lend.
Everything you read about leverage is related to the maximum leverage you can achieve and very little on the cautious use of leverage in a forex trading system. In other words, tell the agency how much it will allow you to leverage, if you want, not how much leverage you need, when you know better.
Warren Buffet said: "Risk is not knowing what you are doing".
People talk about 100:1 leverage - "I trade with 100:1", without knowing what it means. I will below how your worst enemy by being ignorant about this important concept. I hope many of you will get a major "Aha" experience of the newsletter.
Definition of Leverage
This is a general definition : The mechanical power or advantage by using a lever. One definition found on www.investorwords.com says leverage is : "The extent to which an investor or business is using borrowed money".
This is a general definition : The mechanical power or advantage by using a lever. One definition found on www.investorwords.com says leverage is : "The extent to which an investor or business is using borrowed money".
Closer to forex trading: www.thefreedictionary.com
The use of credit or borrowed funds to improve one's speculative capacity and increase the return on investment, as in buying securities on margin.
Enter the concept of "margin". Let us ensure that we understand what margin is:
Definition of margin
The amount of collateral a customer deposits with a broker when borrowing from the broker to buy securities.
This is exactly what you do when you open a forex trading account. You deposit collateral to borrow for currency trading currency. Actually you do not need to borrow, but you can if you want.
When the loan comes into play is well known that the amount that lenders will be willing to Lend has certain limitations. Obviously you can not Lend unlimited amounts.
The thing that stumps most traders is the fact that trade wizards use the terms "leverage" and "margin" very loosely and interchangeably. This causes much confusion. I think it done on purpose because in the interest of the forex broker that traders do not see high-leverage destructive as a problem but as an opportunity.
Let us ensure that we understand first "leveraged" and then "margin".
To understand leverage for marketing purposes, we use a familiar concept. You want to buy a house, you do not have the capital available, but you have a salary and can pay installments on a regular basis, so you go to the bank and borrow money to pay for the house. So you're using your income / salary.
There are restrictions based on, among other things, your income the amount you can borrow based on your income will be limited resources. There is a maximum amount you can borrow. Obvious, yes, but a very important concept for the lenders - the maximum he Lend you in order to maximize the return on his capital gain without exposing themselves to risk of default on your side.
(Just a thought from the sidelines. If forex trading is largely with borrowed money, why not ask the broker interest? Think ....)
Remember this: The lender aims to limits that the borrower should be concerned with minimums - to borrow as little as he can, but is still afraid for his buck.
Now we go back to your trading: you want your speculative capacity increase by using your investment, so you must borrow money to trade with your broker.
Before your broker borrow money you have to deposit margin, you want to liver. Your broker is a wise businessman calculated risks and advance quickly to tell you what is the maximum that it will allow you to borrow from him. In Forex is typically one hundred times your capital, but it can also be two hundred times your capital or even four hundred times your capital. This is a part of the equation:
"Dear customer, you can leverage your money 100:1, (200:1, 400, 1). We hope we have a long and mutually beneficial relationship."
The other side of the equation is how many of these loans available to use in your efforts speculative.
How much leverage you apply your own decision
and not something the agency can force you.
Here is the proof:
We start with a fair example.
To open a trading account with a securities broker, for example $ 10,000. You can buy stocks for the value of $ 10,000. Let's say you did. Do you leverage your money?
No. You have no money to borrow from the broker. You have $ 10,000 and the value of your files when you bought them was $ 10,000 (ignoring the time cost).
How you calculate your leverage?
You divide your capital in the value of your transaction and expressed as a ratio of "value of the transaction" means "capital".
In the above example, you divide $ 10,000 / $ 10,000 = 1:1
Well, the friendly online brokers one days send a message that she now has to review amount trade and you can borrow money to buy shares at the current value of your stocks. For simplicity sake we say that the value of your stock is still $ 10,000. In other words, you can now buy another $ 10,000 worth of stocks, while your capital contribution remains $ 10,000.
You do this after just a hot tip and now you have a transaction value of 2 x $ 10,000 = $ 20,000 divided by $ 10,000 of your capital = leverage of 2:1. Or you can choose not to, it depends on you.
The amount of collateral a customer deposits with a broker when borrowing from the broker to buy securities.
This is exactly what you do when you open a forex trading account. You deposit collateral to borrow for currency trading currency. Actually you do not need to borrow, but you can if you want.
When the loan comes into play is well known that the amount that lenders will be willing to Lend has certain limitations. Obviously you can not Lend unlimited amounts.
The thing that stumps most traders is the fact that trade wizards use the terms "leverage" and "margin" very loosely and interchangeably. This causes much confusion. I think it done on purpose because in the interest of the forex broker that traders do not see high-leverage destructive as a problem but as an opportunity.
Let us ensure that we understand first "leveraged" and then "margin".
To understand leverage for marketing purposes, we use a familiar concept. You want to buy a house, you do not have the capital available, but you have a salary and can pay installments on a regular basis, so you go to the bank and borrow money to pay for the house. So you're using your income / salary.
There are restrictions based on, among other things, your income the amount you can borrow based on your income will be limited resources. There is a maximum amount you can borrow. Obvious, yes, but a very important concept for the lenders - the maximum he Lend you in order to maximize the return on his capital gain without exposing themselves to risk of default on your side.
(Just a thought from the sidelines. If forex trading is largely with borrowed money, why not ask the broker interest? Think ....)
Remember this: The lender aims to limits that the borrower should be concerned with minimums - to borrow as little as he can, but is still afraid for his buck.
Now we go back to your trading: you want your speculative capacity increase by using your investment, so you must borrow money to trade with your broker.
Before your broker borrow money you have to deposit margin, you want to liver. Your broker is a wise businessman calculated risks and advance quickly to tell you what is the maximum that it will allow you to borrow from him. In Forex is typically one hundred times your capital, but it can also be two hundred times your capital or even four hundred times your capital. This is a part of the equation:
"Dear customer, you can leverage your money 100:1, (200:1, 400, 1). We hope we have a long and mutually beneficial relationship."
The other side of the equation is how many of these loans available to use in your efforts speculative.
How much leverage you apply your own decision
and not something the agency can force you.
Here is the proof:
We start with a fair example.
To open a trading account with a securities broker, for example $ 10,000. You can buy stocks for the value of $ 10,000. Let's say you did. Do you leverage your money?
No. You have no money to borrow from the broker. You have $ 10,000 and the value of your files when you bought them was $ 10,000 (ignoring the time cost).
How you calculate your leverage?
You divide your capital in the value of your transaction and expressed as a ratio of "value of the transaction" means "capital".
In the above example, you divide $ 10,000 / $ 10,000 = 1:1
Well, the friendly online brokers one days send a message that she now has to review amount trade and you can borrow money to buy shares at the current value of your stocks. For simplicity sake we say that the value of your stock is still $ 10,000. In other words, you can now buy another $ 10,000 worth of stocks, while your capital contribution remains $ 10,000.
You do this after just a hot tip and now you have a transaction value of 2 x $ 10,000 = $ 20,000 divided by $ 10,000 of your capital = leverage of 2:1. Or you can choose not to, it depends on you.
Vital for the agency: Maximum allowable leverage
The maximum leverage you can apply (as opposed to how much you want to apply) is the decision by your agency:
The most important thing you have to notice in the above example is that you can leverage all authorized by the agency have used. This is vital. The broker takes a huge risk to Lend your money and therefore they have certain rules you must keep. There is a limit to what you can borrow from them. In the above example the limit is leverage of 2:1 or seen from a different point margin of 50%. You must be at least half of the total transaction value of your available margin (ie collateral in case you are not as hot as a dealer you thought).
The margin is usually expressed as a percentage, while leverage is expressed as a ratio.
The marketing wizards of forex realized that the fact that they can offer very high leverage will be to their advantage to lure online investors from traditional markets. Portfolios were also many online investors destroyed by the crash in 2000 and losses of up to 90% of the portfolio formerly lucrative become commonplace - many promoted through stock options.
As a result, they began to tout from the rooftops that the leverage of 100:1, 200:1, and with the introduction of mini accounts, even 400:1 and 500:1 was available.
Terms such as "trade with 100:1" change was the order of the day.
An unsuspecting and clueless online trading public swallowed the hook, line and sinker and were trading with "100:1 and 200:1 leverage", do not understand what they do.
In fact, the agency simply said "we will use your margin to leverage 100:1, 200:1 and 400:1 at the absolute maximum, if all your loans by using our strength."
But you must remember leverage is a two edged sword. It can work for you and against you. And so began a race among the forex losers there: where were the highest leverage, lower margin and smaller spreads are offered? As if this deadly combination would contribute to the success ...
So if you go to your friendly broker who offers both 100K and 10K mini lots you will find lots of 100K lot you usually exceed 100:1 leverage on mini accounts and 200:1 or 400:1.
So that from the angle of the Forex Broker: It will maximum leverage of 100:1, 200:1, 400:1.
Vital for the dealer: Minimum leverage needed
How to leverage your eye (the trader) side?
The demand from you is: How much space do I need for a transaction of a value trade? The answer is simple, if they offer that I can leverage my money 100 times, it is 1 / 100 = 1%, 1 / 200 = 0.5%, 1 / 400 = 0.25%.
If we return to the fair example of the minimum leverage demand plays no role because if you have little money, it would be wise to buy low priced stocks to invest in a basket of stocks.
But in the forex market where the minimum transaction values were initially 100K or 10K and a shell-shocked audience online trading were lured to the "benefits" of the high leverage accounts with only $ 2000 to 3000 dollars or mini accounts from $ 200 -- $ 300 used, the minimum leverage certainly played a role.
To stick it all better I use a real example:
A few years ago a now defunct tip service company did a survey on typical trading forex trading account with 100K lots. The average size of account is an account of $ 6000.
There is no doubt that the average trader will have to borrow money from the broker, namely leverage its funds. The question is "how much"? To do a minimum of 100,000 transactions you divide 100,000 by 6000 and there is the answer: 100,000 / 6.000 = 16.67.
In other words, it must borrow money to make 16.67 times are a minimum transaction and thus using a minimum leverage of 16.67:1. Just to make a stupid trades.
Trading Success: Know your real leverage
I'm not too technical to be the exact impact of these examples.
In fact one U.S. dollars if you take you to pass the transaction value in dollars before you calculate the exact leverage. So if you GBPUSD 100,000 merchant, you actually trade U.S. dollars worth 100,000 pounds, which at the time of writing approximately $ 190,000. There is a big difference between $ 100,000 and $ 190,000. (As Warren Buffet said: Risk is not knowing what you do ...)
With the flexibility of a mini lots (10K), micro lots (1K) and variable lots (any size defines the trader) is easier these days to establish a real leverage because you operate within the extremes of minimum and maximum leverage, leverage.
Let us return to the above questions:
Can you give me the information I can get 1:1 leverage with the company on page 108 of your book called? I use a demo with only $ 1500 on the account with 200:1 leverage and I'm a little worried about this even on 1 mini contract with one currency.
"Give me the information I can get 1:1 leverage?"
Given the fact that leverage is transaction value divided by the capital of the important aspect is your capital and the minimum size of position, because in a position to trade 1:1, you must have at least the same as the minimum capital transaction. In your case, you trade with a broker that variable micro-parties or parties offer no more than 1,500 units.
"I'm using a demo with only $ 1500 on the account with 200:1 leverage"
You refers to the maximum leverage, or the maximum amount they will allow you to borrow. This is a fixed amount (percentage) applies to all trades and transactions not affect your all, while you within this limit.
"I'm a little worried about this even on 1 mini contract with one currency."
First, there is no need to worry about the 200: 1 leverage. It simply means it is the maximum amount you can trade, not what you're forced to trade (it's your choice!). To the trade of the maximum would be really stupid. Your real leverage if you have a mini-contract with $ 1500 trade will be in the region of 6:1 or 7:1. (10,000 / 1,500).
It is interesting that you mention also a coin, because you must know that if you trade 2 or 3 coins simultaneously increases your leverage. Suppose you trade one mini lot EURUSD, GBPUSD and USDCHF, the total value of the units = 30.000 (3 mini-lots) and your capital is $ 1500.
Your leverage is 30.000 / 1.500 = 20:1. That's high. You borrow 20 times what you have.
The profitable forex trading you have a $ 3.00
Here is the proof:
Let's talk about the 200:1 "leverage".
I hope now you understand that this refers to the maximum marketing wizard will allow you to borrow and you can borrow much less impact on your health and your account to survive. But if you go to that extreme, you are really desperate or stupid, and for all practical purposes you are already on the way out.
So what the forex trading wizards call "leverage" is actually the margin is expressed as a ratio rather than as a percentage, which makes more sense and has absolutely no effect on your trading unless you have essentially wiped out or about.
Let's say a trader has $ 10,000 and trades on a broker who provides "flexible leverage".
You can choose your "leverage", 400:1, 200:1, 100:1 or 50:1. What they mean is, you can choose your margin (which will determine the maximum you can borrow from them) is 0.25%, 0.5%, 1% or 2% of transaction value.
Trader decides to buy EURUSD 5 mini lots, ie € 50,000 transaction value and the value of a pip on this transaction is $ 5.00. Let's say he makes 100 pips of profit is $ 500 or 5% of its capital.
The margin requirement is flexible, generally called "leverage" affect the outcome?
The answer is 'no'.
• Leverage = 400:1 = 0.25% = $ 25 X 5 = $ 125. After 100 pips move the Trader makes $ 500.
• Leverage = 200:1 = 0.50% = $ 50 X 5 = $ 250. After 100 pips move the Trader makes $ 500.
• Leverage = 100:1 = 1.00% = $ 100 X 5 = $ 500. After 100 pips move the Trader makes $ 500.
• Leverage = 50:1 = 2.00% = $ 200 x 5 = $ 1000. After 100 pips move the Trader makes $ 500.
It is vital that you Grasp this:
The only variable in this whole exercise is the commercial real leverage, not the required margin.
In the example above, the market moved 100 pips, regardless of the required margin.
The only distinguishing factor is how much the trader borrows from what's available. Depending on how much a trader borrows, he will have a different outcome.
In the example he borrowed 5 times its capital, was levered 5:1 and made $ 500.00. When he was ten times its capital and borrowed was levered 10:1, he would have done the same market move $ 1000 or 10% of its capital. So he borrowed two times its capital 2:1, 2% and so on.
Margin - Leverage - Risk
People wrongly think the risk they take has to do with the margin requirements, forex marketing wizard "leverage".
How many times have you come across money management or risk management systems that say you should not risk more than x% of your capital on a trade?
Let's say our Trader uses this technique and is not 'risk more than 10% of its capital on a trade.
In the above example in the case of 2% margin (50:1 "leverage") the trader "used" 10% of its capital (the margin). (Hopefully you now realize you think he actually risks his capital 10 times!)
So if the approach is that the risk is defined in terms of the range will be "drawn" on the basis of trade will apply the following: Down with the calculators!
Trader has $ 10,000 and is willing to "risk 10%"
• Leverage = 400:1 = 0.25% 10 / .25 = 40. That is, 10% "risk" will be 40 lots or 400K. Real leverage = 400 / 10,000 = 40:1. Pip value = $ 40.00.
• Leverage = 200:1 = 0.50% 10 / .50 = 20. That is, 10% "risk" is 20 lots or 200K. Real leverage = 200 / 10,000 = 20:1. Pip value = $ 20.00
• Leverage = 100:1 = 1.00% 10 / 10 = 1:00. That is, 10% "risk" will be 10 lots or 100K. Real leverage = 100 / 10,000 = 10:1. Pip value = $ 10.00
• Leverage = 50:1 = 2.00% 10 / 5 = 2:00. That is, 10% "risk" is lots 5 or 50K. Real leverage = 50 / 10,000 = 5:1. Pip value = $ 5.00
This same strategy for risk than commonly stated, no more than x% of your capital risk in potential losses, so calculate your stop-loss point advance as a percentage of the capital. So a stop-loss is generally set at 2% or 3% of the capital.
In this case, if 2%, the maximum loss value $ 200 (2% of capital of $ 10,000). But as you have now seen the first part pit incorrectly calculates the value based on a pseudo-principle (for the leveraged trader), while the dealer supposedly "risk" 10% of its capital in all four cases.
• Leverage = 400:1, Pip value = $ 40.00, "10% risk. The stop-loss of 2% should be 5 pips.
• Leverage = 200:1, Pip value = $ 20.00, "10% risk. The stop-loss of 2% to 10 pips.
• Leverage = 100:1, Pip value = $ 10.00, "10% risk. The stop-loss of 2% to 20 pips.
• Leverage = 50:1, Pip value = $ 5.00, "10% risk. The stop-loss of 2% to 40 pips.
It is clear that the above statements, a misunderstanding of the leverage effect can be devastating to your chances of success.
It also shows that many so-called money management systems are absolutely bogus - spreadsheet theory - and have nothing to do with real profit making business.
Suffice to say that, while the 400:1 and 200:1 "Utilized options are not so much seduced by the 100:1 and 50:1 options, as suggested by almost all experts out there, accompanied by the need 20, 30 and 40 pip stops all the time hit (followed by the inevitable market move in your first expected direction).
Summary
• What is usually referred to as leverage is actually the required margin, expressed as a ratio, if all loans you will use the power broker.
• Real leverage your capital is determined by the value of your positions.
• Real leverage may differ from trade to trade and increases with multiple simultaneous transactions.
• The required margin does not affect your risk when you trade with modest leverage well within your means and will not be used as a principle Calculation of the risk.
