Leverage?

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LiamH

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I keep reading that leverage is a double edged sword - It can help realise large profits but at the same time gives a high risk of large losses.

Why is this? I mean, I understand what leverage is but if my stop is set at 3% of my account then surely only slippage is going to cause me to lose more than 3%?

In spreadbetting huge leverage is automatically added to an account is it not?

So, as an example. Let's say I have a £1000 account and I want to take a trade on cable. I risk 3% (£30), I decide a good place for my stop is 60 points away and so my trade will be 50p per point. To trade at 50p per point and still have margain for other positions I might decide I want to use 20% of my account for margain... This means I have £200 to cover this position.

At 50p per point I need to be holding 5 x 10k lots (50k units of USD) which is £35k or thereabouts. Divide this by £200 = 175. My leverage on this trade is 175x but my actual risk is only 3% because of my stop.

Have I got this right or am I being an idiot and missing something big? I understand that my calculations might be a little off as I have only used spreadbetting before and not a forex broker using lots so am still getting used to working everything out in units of currency.
 
LiamH said:
I keep reading that leverage is a double edged sword - It can help realise large profits but at the same time gives a high risk of large losses.

Why is this? I mean, I understand what leverage is but if my stop is set at 3% of my account then surely only slippage is going to cause me to lose more than 3%?

In spreadbetting huge leverage is automatically added to an account is it not?

So, as an example. Let's say I have a £1000 account and I want to take a trade on cable. I risk 3% (£30), I decide a good place for my stop is 60 points away and so my trade will be 50p per point. To trade at 50p per point and still have margain for other positions I might decide I want to use 20% of my account for margain... This means I have £200 to cover this position.

At 50p per point I need to be holding 5 x 10k lots (50k units of USD) which is £35k or thereabouts. Divide this by £200 = 175. My leverage on this trade is 175x but my actual risk is only 3% because of my stop.

Have I got this right or am I being an idiot and missing something big? I understand that my calculations might be a little off as I have only used spreadbetting before and not a forex broker using lots so am still getting used to working everything out in units of currency.
Click to expand...

No your correct. If you adjust your position size to match the SL you cant go to far wrong..unless your method is pants and your risk per trade is to high but that has little to do with your question ;)

People tend to fall foul by having more than one position on different instruments and therefore take lots of losses in one swoop. The other thing is taking your stop off after you've put a leveraged trade on etc.
 
OK, thanks for the reply Sven. So basically, provided sound MM is adhered to and the strategy has a positive expectancy then there is no reason for leverage to cause a problem?
 
exactly. in the world of margin trading if you have a specified risk then the leverage used is pretty meaningless.
 
Caution.... Your stop loss will not protect your from overnight or weekend gaps. If you use high leverage with a nice 3% stop and the eur gaps an unprecendented 150 points against you, your 3% stop turns into margin call. This goes with anything, I just used eur as an example because this is what happened to many traders last week. Using excessive leverage, even if you have a 1 tick stop will eventually kill you. Skilled daytraders can use slightly more leverage because gap risk is lower, but still, protecting your capital is your number one goal.

Peter
 
i agree with you wackypete2.. If this happened to us the first thing that we can do is to protect our capital because that is the best and the first thing that we should do.

thanks,
 
Last edited by a moderator:
wackypete2 said:
Caution.... Your stop loss will not protect your from overnight or weekend gaps. If you use high leverage with a nice 3% stop and the eur gaps an unprecendented 150 points against you, your 3% stop turns into margin call. This goes with anything, I just used eur as an example because this is what happened to many traders last week. Using excessive leverage, even if you have a 1 tick stop will eventually kill you. Skilled daytraders can use slightly more leverage because gap risk is lower, but still, protecting your capital is your number one goal.

Peter
Click to expand...

Valid point, you could always set your max account leverage to mitegate that risk. It wont remove it completely but may help you sleep better.
 
Leverage is a two edged sword because of the pain it can bring. I used the term in another thread because one chap was talking about using 100:1 leverage for some trade or another. This is how the spread brokers advertise, through offering ridiculous leverage.

It's leverage which got us into the credit mess... 100 pct mortgages and the like. Leverage is like anything, use in moderation.
 
meanreversion said:
Leverage is a two edged sword because of the pain it can bring. I used the term in another thread because one chap was talking about using 100:1 leverage for some trade or another. This is how the spread brokers advertise, through offering ridiculous leverage.

It's leverage which got us into the credit mess... 100 pct mortgages and the like. Leverage is like anything, use in moderation.
Click to expand...


That chap was me! I see all the points made here, unfortunately two of them are contradictory and both make sense to me.

Leverage can only kill my account if the market moves further than my stop without it being filled. The next thing for me to do is find out how likely this is if I never trade during news and don't hold positions over the weekend.

I understand that a 1% move against my position with 100x leverage will bust my account but how likely is that to happen? I suppose natural disasters and wars would be my worst enemies when using high leverage?
 
Start by reading books, then formulate a plan, then open a demo account, then if successful start small and build from there.

I typically hate analogies but you wouldn't jump straight into the cockpit of a 777 without reading a few flying manuals first? (Not that trading is anywhere near as difficult as flying, but you take the point)
 
I'm confused......

So effectively if I'm using 100:1 leverage and set a S/L at 20 pips away and use 0.5 (50p per pip) if I were to drop down to 50:1 leverage I could set my stop at 40 pips away and still only lose the same amount of money? Is that right?

God I really should know all this by now, this is basic stuff, how have I not learned this??? :confused:
 
If a hedge fund uses leverage of 100:1, and a fund of fund uses borrowed money to invest in other hedge funds, also with leverage of 100:1, does that mean combined leverage is 10,000:1?
 
meanreversion said:
If a hedge fund uses leverage of 100:1, and a fund of fund uses borrowed money to invest in other hedge funds, also with leverage of 100:1, does that mean combined leverage is 10,000:1?
Click to expand...

If Peter Piper picked a piece of pickled pepper ........
 
How do you confuse an Irishman?

Put a shovel and a spade in the corner and ask him to take his pick.
 
Come to think of it, you get nice leverage with tools like this, but is it more like 5:1 than 100:1?
 
Your tag line is good. Another good one I saw today was "a wise man learns from his mistakes, an even wiser man learns from other people's mistakes". Ok, signing off now
 
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