The Risks of Leverage

You have already learned about leverage’s significance and its possibilities. With leverage, you can multiply your profits and earn much more than your actual money could have made. But in this section, we will discuss Leverage’s consequences. You will understand why irresponsible leverage might be devastating for your capital. The number one reason for traders’ commercial demise is high leverage! Necessary: Relatively low leverage can create tremendous profits for us! Leverage- Controlling a large amount of money while using a small part of your own money and “borrowing” the rest from your broker.

Remember: We recommend you not work with a leverage of more than x25 (1:25) under any conditions! For example, you should not open a standard account (USD 100,000) with USD 2,000 or a mini account (USD 10,000) with USD 150! 1:1 to 1:5 are good leverage ratios for large hedge funds, but for retail traders, the best ratio varies between 1:5 and 1:10. Even very experienced traders who consider themselves big risk lovers do not use leverage of more than x25, so why should you? Let’s study the market first, earn some real money, and get some experience working with low leverage, then move to slightly higher leverage. Some commodities can be very volatile. Gold, Platinum, or Oil move hundreds of pips in a minute. If you want to trade them, your leverage must be as close to 1. You should protect your account and not turn trading into a gamble. Example: This is what your account would look like when you open a USD 10,000 account:

Let’s assume you open a position with USD 100 initially:

Assume that you decide to open 79 more lots on this pair, meaning a total of USD 8,000 will be in use:

Right now, your position is very risky! You are totally dependent on the EUR/USD. If this pair goes bullish you win a lot of money, but if it goes bearish you are in trouble! Your equity will decrease as long as EUR/USD loses value. The minute the equity falls under your used margin (in our case USD 8,000), you will receive a “margin call” on all your lots. Say you bought all 80 lots at the same time and at the same price: 25 pips decrease will activate a margin call. 10,000 – 8,000 = USD 2,000 loss because of 25 pips!!! It can happen in seconds!! Why 25 pips? In a mini account, each pip is worth USD 1! 25 pips scattered over 80 lots are 80 x 25 = USD 2,000! At that exact moment, you lost USD 2,000 and are left with USD 8,000. Your broker will take the spread between the initial account and your used margin.

We still have not mentioned the spread that the brokers take! If in our example the spread on the pair EUR/USD is fixed at 3 pips, the pair needs to decrease only 22 pips for you to lose USD 2,000! Important: Now you understand why it is so important to set a Stop Loss for every position you open!! Remember:  In a mini account, each pip is worth USD 1; in a standard account, each is worth USD 10.

If you buy a pair with a standard lot (USD 100,000) and its value goes down 1%, this is what would happen with different leverages: High leverages, such as x50 or x100, could produce astronomical gains of tens and hundreds of thousands of dollars in a very short time! But you should only consider this if you are prepared to take serious risks. A trader can use these high ratios only in extreme conditions when the volatility is low, and the price direction is almost 100% confirmed, probably around the time the US session closes. You can scalp a few pips with high leverage because the volatility is minimal, and the price trades in a range, which makes the direction easily detectable in the short term. Remember: The ideal combination is low leverage and significant capital on our accounts.