Recently, we saw Cysec and FCA issued an announcement respectively about lower the trading leverage. Now we analyze it from the side of trading action not on whether it will have great impact on brokerage service.
When we are on the forex trading, we always heard someone discussing a question whether higher leverage equals higher risk. Some maintains opinion of yes, but others no. In fact, the purpose of leverage is to allow you to trade with less money. The determinant factor of risk is position size not leverage, and what leverage matters is margin rather than risk. Let’s make it more clear by below example.
1) Leverage 1:100, trade 1 lot of EUR/USD, the margin is 1000 USD. Whenever the market fluctuates 1 pip, your equity will be 10 dollar profit or loss.
2) Leverage 1:500, trade 1 lot of EUR/USD, the margin will be 200 dollar. Still 1 pip presents 10 dollar profit or loss on your equity.
Therefore, the relationship between leverage and risk should be described as “high leverage has more capacity to burden high potential risk”. In other words, high leverage gives you more freedom to burden your risk. Compare with low leverage, same mount of money allows you to trade more position size on high one but with more risk.
However, when on a real trading, the situation is much more complicated. Just as we talked above, traders will evaluate the risk not by leverage, even they think leverage, position size and risks have no direct relations, they are independent. High leverage lower the trading admission and gives more opportunities to the one with less trading money as well as provide more space for gambling trading. Risk is determined by both position size and stop loss. When on trading, they will manage the position size by the maximum % risk of an account and positive stop loss. Therefore if you controlled your position size well, you can manage your account risk well.
All in all, high leverage doesn’t equal high risk. High leverage account just opens the door to high risk invest.
When we are on the forex trading, we always heard someone discussing a question whether higher leverage equals higher risk. Some maintains opinion of yes, but others no. In fact, the purpose of leverage is to allow you to trade with less money. The determinant factor of risk is position size not leverage, and what leverage matters is margin rather than risk. Let’s make it more clear by below example.
1) Leverage 1:100, trade 1 lot of EUR/USD, the margin is 1000 USD. Whenever the market fluctuates 1 pip, your equity will be 10 dollar profit or loss.
2) Leverage 1:500, trade 1 lot of EUR/USD, the margin will be 200 dollar. Still 1 pip presents 10 dollar profit or loss on your equity.
Therefore, the relationship between leverage and risk should be described as “high leverage has more capacity to burden high potential risk”. In other words, high leverage gives you more freedom to burden your risk. Compare with low leverage, same mount of money allows you to trade more position size on high one but with more risk.
However, when on a real trading, the situation is much more complicated. Just as we talked above, traders will evaluate the risk not by leverage, even they think leverage, position size and risks have no direct relations, they are independent. High leverage lower the trading admission and gives more opportunities to the one with less trading money as well as provide more space for gambling trading. Risk is determined by both position size and stop loss. When on trading, they will manage the position size by the maximum % risk of an account and positive stop loss. Therefore if you controlled your position size well, you can manage your account risk well.
All in all, high leverage doesn’t equal high risk. High leverage account just opens the door to high risk invest.