Forex traders have always viewed higher leverage as an important determinant in their choice of broker. The higher the better; one broker with 400 times leverage factor is better than another broker with 50 times leverage. Put in less money with the broker and you can trade higher volume quantity that is the better broker, if all other considerations are the same. Is higher leverage necessary or do traders really use 400x leverage? What are the effects when a FX trader uses maximum leverage? In this article, we will examine the effect of leverage and what is the true leverage used when investors trade.
First, when we talk about 400x or 50x leverage, we are talking about maximum leverage an account holder can utilize. This is the maximum a broker offers to his clients. It refers to certain currency pairs and definitely does not apply to all currency pairs. For 400X leverage, it is more likely to apply to the major currency pairs and definitely not the crosses. If you trade AUD/JPY, you are unlikely to get the maximum leverage your broker offers. Even for brokers that offer 50x leverage, AUD/JPY is likely to be on 25x leverage instead of 50x.
Now let’s look at this leverage factor again. For example, if a client puts in a US$5,000 deposit, if his broker offers 400x leverage, he will be able to trade up to US$2 million. If another broker offers only 50x leverage, the maximum the client can trade is US$250,000. If the trader trades 1 standard lot of EUR/USD, he would have used up only US$280 of his US$5000 deposit if he is on 400x leverage. If the leverage was 50x, he would have used up US$2,240 of his deposit. If he trades on 1 standard lot, leverage of 50x is more than sufficient with a US$5000 account. 50X or 400x will not make any difference to the account holder.
Now if the trader decides to take advantage of his broker’s generous offer of 400x leverage, and take the maximum trading size of US$2,000,000, he would be able to short 17 standard lots of EUR/USD at 1.1200. With an account balance of US$5000, trading with 17 standard lots on 400x leverage, a movement of 15 pips against your trade would have resulted in an auto liquidation of the position. 15 pips would result in a loss of US$150 for every standard lot. An account with 17 standard lots would have lost US$2550. While there is enough money in your account, the margin is now less than 50% and most brokers have this 50% auto liquidation function in their MT4 platform. 15 pips movement is not much for EUR/USD which has a daily range of 70-80 pips. In fact, in an hour, your account could have lost half its value. The wisdom in risk management has been: Risk no more than 2% of your account.
When looking at Forex trading, risk management like stop loss is important. Trading size should be a more important consideration, rather than the broker’s leverage offered. Choosing a lower leverage will not result in overtrading as well.