Trade with an Edge

Trading Leverage

A major reason new traders fail is due to trading leverage being too high. Their account balance is too small compared to their open trading positions - or too many lots are being traded for the account size.

Leverage is calculated as follows. Divide total contract size into your account balance value.

So, for example:

Let's say account balance is $20K in a mini account ($10k lots) and you have 5 trades of 2 lots each open. This means your total contract size is $100k.

Your trading leverage is therefore 20,000/100,000. ie 5:1 trading leverage.

How much leverage is too much?

Richard Olsen, co-founder of FX brokers Oanda, made a study that showed optimum returns in the forex markets occur at a leverage of 4:1. More than that and it's likely that your drawdown is unsustainable and will eventually blow your account

Most professional traders and money managers trade one standard lot ($100K) for every $50k in their account. That's a leverage of 2:1. In a mini account, this translates to one mini lot ($10K) for every $5k.

Some forex brokers seem to encourage over-leveraging by advertising high-leveraged accounts - for example 200:1 - as if it's a good thing. It's not. Just because they offer that high leverage, doesn't mean you have to use it of course.

Here's an example to illustrate the point. Consider two trades, A and B:

	A	B
Account Balance	$10,000	$10,000
Leverage used	50:1	5:1
Value of open positions_______	$500,000	$50,000
100 pip loss ($2 /pip)	$2,000	$200
% of account left	80%	98%

Trader A could only survive another 4 of these trades and then would be wiped out. Trader B could sustain a lot more losses and still be in the game.

What should a starting account balance be?

It is normally recommended you have at least have $100,000 of trading capital before opening a standard account, $10,000 for a mini account, or $1,000 for a micro account.

What Is My Rule for Trading Leverage?

Personally, I tend to keep my leverage below 5:1. That would be a maximum and I rarely use that level. In fact most times I'm trading at a leverage of 1:1 or 2:1.

It grows my account more slowly than highly-leveraged traders - but on the other hand, I'm still in the game.

Other pages in this series on Harmonics Basics are: