A better explanation of Leverage.

[sharesr4us]

Hi everyone,

I've been very helpfully informed by the few on this forum of what stop loss, guaranteed stop loss and limits are.

My next question is what is a Leverage and how it affects me, but as almost always I would like to present a scenario as this is the best way I tend to understand.

Lets say tomorrow I want to trade on IG Index and see the following:-

GERMANY 30 - ~Price: Sell=1000, Buy=1010

I decide to buy @ 1010 as I can see the price is slowly climbing. I place a bet of £1 per point @ 1010 and place a stop loss of 100 points.

The market goes down fairly quickly, but not superfast on bad news and ends up at 9000 and due to a system problem, I can't stop my trade in time &/or IG Index don't stop it in time.


1. How does leverage come into play with the above scenario?

2. What sort of losses would I incur assuming I had a standard stop loss?

3. Would any company be responsible for my loss, assuming I had a stop in place?

Thanks again

 

[new_trader]

1. How does leverage come into play with the above scenario?

Leverage is always in play. The minimum bet on the Dax30 is £2/point. The current level of the Dax30 is 10920. Therefore @ £2/point the index is worth £21,840. But, you only need to put down around £100 margin to enter a trade @ £2/point. Therefore you are 'controlling' £21,840 worth of assets with only £100.

2. What sort of losses would I incur assuming I had a standard stop loss?

Loss = points x (amount/point)
(points might include slippage)

3. Would any company be responsible for my loss, assuming I had a stop in place?

Not sure, good question. I would imagine they would honour a stop if the problem is related to a technical failure. There is probably something about this in their T&C which nobody ever reads.

 

[Revorocks]

Leverage just allows you to trade stuff you could not normally afford.
The amount of capital required to buy enough currency so that the small % changes in value equates to a good amount of movement is quite large.

Same goes for contracts in indices. Approx 10,000 for 1 contract of dax.
Requires a 10000 euro investment for 1 euro per point. With leverage you can get way more contracts for a smaller amount of capital, just your losses are magnified as well as your gains.

If you have a £1 pp bet placed, it goes from 1010 to 900, thats a net of 110 points, so a loss of £110...
Nothing else to it. And no, unless your stop us guarunteed they are not responsible for your loss.

Stop loss will just try to close your position at a certain price. If it skips past that price because they didn't offer it/order wasnt filled then you will lose more. It's very rare that it happens though.

 

[sharesr4us]

Thank you guys. I know I've already asked a similar question previously, but I panicked after I read a comment on this forum that the amount of leverage is the amount of loss you can incur. So for example if you have a leverage of £20000, thats the amount you can risk upto...even with that stop.

 

[new_trader]

Thank you guys. I know I've already asked a similar question previously, but I panicked after I read a comment on this forum that the amount of leverage is the amount of loss you can incur. So for example if you have a leverage of £20000, thats the amount you can risk upto...even with that stop.

I don't think have fully grasped it yet. Leverage is a ratio. e.g. 400:1, 10:1

It makes no sense to say a leverage of £20000.

What you probably read was that losses can exceed your deposit.

 

[NVP]

most broker websites have good explanations - better still phone them up and ask those questions .................its in their interest to teach you

N

 

[sharesr4us]

I don't think have fully grasped it yet. Leverage is a ratio. e.g. 400:1, 10:1

It makes no sense to say a leverage of £20000.

What you probably read was that losses can exceed your deposit.

Yes, sorry, your right...it said something about leverages and then about losses can exceed deposit.

most broker websites have good explanations - better still phone them up and ask those questions .................its in their interest to teach you
N

I actually rang IG yesterday, but the guy on the phone simply pointed me to their
website.

 

[mike.]

A simple way to understand leverage is, think about buying a house but your only going to own it for a hour because you want to make a quick profit. Ok, you put your 1k deposit down and the bank lends you 20k. So at this moment you own a 21k house with a small deposit. The bank has leveraged you to the tune of 20:1...The house price rises to 23k and you sell, the bank takes his money back plus a commission for lending it to you. The rest is your profit. If you want to buy a more expensive house next time then you will have to hold more funds in your account to prove you can afford it if the price falls, this is called margin. Hope that makes sense.

 

[sharesr4us]

Thanks for the the great explanation mike. I'm happy you've explained the making profit side mate, but could you kindly also explain a similar scenario when it comes to loss?

 

[mike.]

Ok. So the same house starts to fall in price, you sell at 19k. You still need to pay the bank his 20k back also his comission say 100quid, so now you at a loss of 2.1k.

Leverage doesn't really come into affect when Spreadbetting as such, for example, you bet the dax to go up at £1 per point, if there is a two point spread then as soon as you place the bet you are instantly £2 down in your profit/loss column, this is the brokers commission for taking the trade, so in effect the dax has to move up two points to put you in a breakeven position, only when it goes up more than the two points are you in profit.

,

 

[sharesr4us]

Thanks mike. I am now a bit lost. Because in your example I would have to you have said that I would have to pay back the bank's 20k, which would mean £20100, and not 2.1k, wouldn't it?

Unless what you meant is that I would lose:-

1. My 1k +
2. The Drop in price of 1k +
3. banks commission of £100k, i,e the spread????

Also, below is an example of how I'm trading on a demo IG index account. Note that stops and limits. You will notice that I have set 100 point GUARANTEED stop loss and 100 point limits too. The reason for this is because I can't be watching the computer screen all day due to work and responsibilities and need to have peace of mind, hence a guaranteed stop loss has been set.:-

Please let me know if I'm doing that wrong.

 

[mike.]

No, the house was 21k, you sold for 19k = 2k loss.£100 broker comission = 2.1k loss. But I think your getting to tied up in leverage when it doesn't really apply to Spreadbetting, it comes into affect more with cfd trading.

If you think along the lines of every time a instrument, say the dax moves one point in the direction I bet it to move then for every point you win your stake you put on, be it 1 pound per point or 100 pound per point, every point in the opposite direction you loose your stake for each point.

 

[mike.]

With ref to your chart, you are trading a 1:1 risk reward plus loosing the spread, therefore , your strategy is set up to loose more than you win, you should be looking towards at least 1:2 risk reward, I.e. 50 point stop and 100 limit order. Imo.

 

[sharesr4us]

The reasons I am concerned about leverage is because I worry about the market crashing through my stop loss, For example me betting £2pp on market to go up from 1100, my stop loss set to a 1000 points, but market instead crashes through to 9500 etc. That would mean a massive loss and it could have devastating consequences.
Hence what if the market went past a stop loss massively.

I know time and time again many on here have advised that it's a very rare event, but as a beginner, I have to keep that in mind.


Your right in saying that the my stop and profit limit is 1:1, but the problem I have is that the market is very liquid and moves very fast either way. I always bet a 100 points each way for this reason as I know I am taking a larger risk, but my rewards will be high too. Assuming we take out the spread/commision, I can win/lose £300 each way on a £3pp bet. 50 points imo is simply not enough considering how quick and how much distance the markets can move.

Let me clarify one thing though...the amount of stop loss/limit (100 points) is what is my maximum....This doesn't mean that I'll leave it there all the time. If I check and find that I've made some profit, I tend to sell very quickly and lock-in on my profits and vice-versa for losses too.

BTW, those same losing spreads your referring to are actually winners as I waited :-

 

[alexaherself]

The reasons I am concerned about leverage is because I worry about the market crashing through my stop loss

That's certainly an issue, and you're right to be aware of it, and you're right to have taken on board that it can effectively be avoided by paying more for a guaranteed stop ... but it doesn't have anything to do with "leverage".

Leverage as such is not involved in spread-betting.

For example me betting £2pp on market to go up from 1100, my stop loss set to a 1000 points, but market instead crashes through to 9500 etc. That would mean a massive loss and it could have devastating consequences.

Yes indeed. If that happens you can lose a lot more than you expected, which is why all those spreadbetting firms are legally obliged to state clearly when you open an account that you can lose more than just the funds in your account. But if you pay extra for a guaranteed stop, in exchange for that they undertake to treat your bet as if the market didn't crash through your chosen stoploss-level, and honour it. That way, they're effectively taking on that risk instead of you taking it on, but you're paying extra for that privilege all the times that doesn't happen (which is nearly always).

 

[sharesr4us]

Firstly, thank you alexa for being understanding.

Also I'm sorry alexa, i keep forgetting and saying leverage, but as New_Trader pointed out earlier, I'm actually referring to the term "LOSSES CAN EXCEED YOUR DEPOSIT".

 

[alexaherself]

Yes - I hear you. They have to say this for legal reasons, because losses can exceed your deposited funds under exactly the circumstances you're asking about. (But not if you pay for a "guaranteed stop" on every trade: under those circumstances, losses can't actually exceed your deposit.)

 

[new_trader]

Firstly, thank you alexa for being understanding.

Also I'm sorry alexa, i keep forgetting and saying leverage, but as New_Trader pointed out earlier, I'm actually referring to the term "LOSSES CAN EXCEED YOUR DEPOSIT".

In order to trade effectively you cannot be so obsessed with the amount you can lose. All traders are aware of the risks but if the fear is almost debilitating then you are unlikely to ever make real progress.

I have an IG account and I also have a City Index account.
http://www.cityindex.co.uk/

I strongly recommend you find a SB company that has minimum bet sizes that are lower than IG. The minimum bet sizes on City Index are much lower than IG and I think you would be better off trading with such a SB company until you are comfortable and experienced with the idea of betting with real money.

As an example: The minimum size on the ES with IG is £20/point. With City Index it is only 50p/point!

I'm not necessarily recommending City Index even though so far I am happy with their Platform, I am just suggesting you find another SB broker who allows much smaller minimums.

 

[sharesr4us]

thanks alexa and new_trader.

@ new_trader - I've actually been looking for a sb company which has lower spreads. I tried cityindex, but their platform seems to slower than ig's and freezes a lot for me. No idea why it does that as it is a great platform otherwise. Just FYI, it's not my internet connection as I'm on a 100mb broadband connection with a very low ping rate (15-16ms). I have a clean install of windows which runs very smoothly, so no software issues either.

The other thing I look for is android software and again IG and CMC are very stable, but not tried city index.

I really like CMC as it's stable, but I find their style of placing bets a tad confusing, compared to others.

Maybe someone can help me with CMC???

or

Explain why my system seems to be having problems with city index???