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Is high leverage really bad for traders?

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  • First Post: Edited Mar 21, 2007 3:00am Mar 20, 2007 9:04pm | Edited Mar 21, 2007 3:00am
Here is a another typical trading myth: high leverage is bad for you! You see this idea in every futures/forex forums over and over again.

This is of course total nonsense and here is why.

Each time you open a 100 to 1 (or more) leverage position in a forex mini-account, your friendly forex dealer is simply saying this : "Hey Mr. Trader, just put $100 in your account plus cost of spread and I will let own $10,000 worth of currency, and if the market moves just 1% in your favor you make 100% profit on your margin money, less cost of spread and a possible small interest!"

This "high-leverage-is-bad" myth is based on a simple confusion : most traders, newbies (and some pros alike!) assume that leverage means your total trading balance divided by the value of your position.

Your trading balance has of course NOTHING to do with leverage!

It does not matter if your trading balance is $1,000,000 or $100, if you open a position and you only need $50 to own/control $10,000 worth of currency then you are trading with a 200:1 leverage, period.

So high or low leverage, it does not matter. HOWEVER, what is really, really important is the percentage allocated to each trade. If you open a forex position and you need $5000 margin money and that margin money represents 100% of your trading balance then "Houston we've got a problem" indeed, no doubts about that.

In fact, if a trader has an excellent forex trading system, then the optimal course of action is to choose the highest leverage possible (400:1), to allow for a fast compounding of profits.


PS: this thread is NOT an invitation to trade with higher/lower leverage, as always trade at your own risk.
It seems that you trying really hard to make a name for yourself on this forum. You’ve been posting a lot lately and you are trying to show your vast knowledge in all trading related areas. However it is obvious that at times you are trying too hard. Normally I do not post much or engage in any discussions especially lately, but I feel compelled to reply to your post since I have a few problems with it.

Quoting FXTerminator
This "high-leverage-is-bad" myth is based on a simple confusion : most traders, newbies (and some pros alike!) assume that leverage means your total trading balance divided by the value of your position.
First of all you are speaking with a lot of authority for a lot of traders. It is also funny that you set yourself above the professional traders. Even though they are professionals some of them still (in your opinion) do not understand and are confused about the simple concept of leverage. It cracks me up when someone comes on a public forum and makes all this claims about professional traders. But at least the claims usually are about how they trade and what tools they use. You took this one step further by pointing out the misconceptions they have about leverage.

Quoting FXTerminator
In fact, if a trader has an excellent forex trading system, then the optimal course of action is to choose the highest leverage possible (400:1), while still keeping the % of trading balance allocated to each trade under 2% or less to allow for a fast compounding of profits.
The above statement contradicts itself and shows that you might actually be one confused about leverage. Here is why:

Lets say your
Account:10000$;
Risk: 2%;
So you can risk 200$.
Now let’s assume that your Stop Loss is 50 pips and that 1 pip=1$.
From this you position size is 4 Mini Lots or 40000$.
So for you to be able to take this position with the size of your account you would only need 4:1 leverage. Even if we assume that you would have ten positions opened in the same time with the same risk percentage you would only need 40:1 leverage and your total risk exposure would be 20% of your account – not a wise thing to do. So it seems that even with excessive risk you do not need leverage above 40:1. However you state that one should choose the highest possible leverage(400:1). Why? To me this is poor understanding of either leverage or risk management or maybe both.

Those high levels of leverage are usually offered by brokers that play against their clients. Because someone who does not understand money management will be able blow their account much faster with high leverage. And the faster they blow their account the faster the broker profits. Oanda for instance has their highest leverage at 50:1 and it never crossed my mind that this is a problem. Such “Low” leverage comes from a broker who tries to protect their clients.

So next time before you come and try to sound as such an expert take a couple of minutes and think. After all some newbie might actually believe that you are all that great and take your advice for granted. Maybe that is the reason most traders fail. They listen too much and think for themselves too little.
Stubbornly persistent
Quoting sergiu
It seems that you trying really hard to make a name for yourself on this forum. You’ve been posting a lot lately and you are trying to show your vast knowledge in all trading related areas. However it is obvious that at times you are trying too hard. Normally I do not post much or engage in any discussions especially lately, but I feel compelled to reply to your post since I have a few problems with it.



First of all you are speaking with a lot of authority for a lot of traders. It is also funny that you set yourself above the professional traders. Even though they are professionals some of them still (in your opinion) do not understand and are confused about the simple concept of leverage. It cracks me up when someone comes on a public forum and makes all this claims about professional traders. But at least the claims usually are about how they trade and what tools they use. You took this one step further by pointing out the misconceptions they have about leverage.



The above statement contradicts itself and shows that you might actually be one confused about leverage. Here is why:

Lets say your
Account:10000$;
Risk: 2%;
So you can risk 200$.
Now let’s assume that your Stop Loss is 50 pips and that 1 pip=1$.
From this you position size is 4 Mini Lots or 40000$.
So for you to be able to take this position with the size of your account you would only need 4:1 leverage. Even if we assume that you would have ten positions opened in the same time with the same risk percentage you would only need 40:1 leverage and your total risk exposure would be 20% of your account – not a wise thing to do. So it seems that even with excessive risk you do not need leverage above 40:1. However you state that one should choose the highest possible leverage(400:1). Why? To me this is poor understanding of either leverage or risk management or maybe both.

Those high levels of leverage are usually offered by brokers that play against their clients. Because someone who does not understand money management will be able blow their account much faster with high leverage. And the faster they blow their account the faster the broker profits. Oanda for instance has their highest leverage at 50:1 and it never crossed my mind that this is a problem. Such “Low” leverage comes from a broker who tries to protect their clients.

So next time before you come and try to sound as such an expert take a couple of minutes and think. After all some newbie might actually believe that you are all that great and take your advice for granted. Maybe that is the reason most traders fail. They listen too much and think for themselves too little.
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Sergiu vs Terminator


Terminator


Sergiu


Me
Quoting kharvell
Sergiu vs Terminator


Terminator


Sergiu


Me
Isn't it amazing what you can say in emoticons!!!!!! LOL
To be honest, I'm confused as well with this leverage stuff. But here's how I view it. Please feel free to "bash" (read: educate) me up....

Say account of $250 trading 0.10 microlots ~ $0.10/pip of EURUSD.

With 10:1 leverage, you need a margin of ~ $133
With 200:1 leverage, you need a margin of ~ $6

Now, you opened a trade with 50pips SL. It was stopped out. That translates to a loss of $5 -- whichever leverage you're using.

I guess the dangerous part here is, if you're using 10:1 leverage, after opening 1 trade as per above, you will "only" now have a free margin of ~ $117. But using 200:1 leverage, you will still have a free margin of ~ $244. And because of this, the temptation to open up more trades is higher since your free margin is higher. And of course, more open trades means more risk.

I suppose bottomline is, no matter what leverage you're using, as long as you have the proper risk/money management you can stay in the game longer as you can imagine....
Wall,

I think this is a very insightful post.

The problem with leverage is and has always been about temptation. Personally, I see no problem with having 400:1 or even 1000:1 leverage, but that's because I've learned to control the urge to use the leverage.

Whether or not this is a good thing is a very individual decision, BUT the recommendations for NOT using higher leverage are very sound. I personally, have the common 50:1 or 100:1 leverage or even 200:1 leverage with my mini accounts, but I don't actually max out my leverage. I trade according to my risk profile, and that is what I recommend for anyone.

Leverage is merely a tool. If you know how to use it wisely, then it can be useful. If you don't, then you'll hurt yourself.

The argument for or against it will be as old and as tired as they come in the FX world, but the argument is helpful to warn users of the dangers of maxing out leverage and not trading according to your risk profile.

FXT and Ser pointed out very excellent points...and they should be commended for stating the less-than-obvious. Deriding each other on those points is not exactly productive, in my opinion because I believe that leverage is and always has been a personal decision...for me, the math works out whether I have 1:1 leverage or 1000:1...I can't say the same for anyone else.

Quoting wallym
To be honest, I'm confused as well with this leverage stuff. But here's how I view it. Please feel free to "bash" (read: educate) me up....

Say account of $250 trading 0.10 microlots ~ $0.10/pip of EURUSD.

With 10:1 leverage, you need a margin of ~ $133
With 200:1 leverage, you need a margin of ~ $6

Now, you opened a trade with 50pips SL. It was stopped out. That translates to a loss of $5 -- whichever leverage you're using.

I guess the dangerous part here is, if you're using 10:1 leverage, after opening 1 trade as per above, you will "only" now have a free margin of ~ $117. But using 200:1 leverage, you will still have a free margin of ~ $244. And because of this, the temptation to open up more trades is higher since your free margin is higher. And of course, more open trades means more risk.

I suppose bottomline is, no matter what leverage you're using, as long as you have the proper risk/money management you can stay in the game longer as you can imagine....
Quoting sergiu
. Here is why:

Lets say your
Account:10000$;
Risk: 2%;
So you can risk 200$.
Now let’s assume that your Stop Loss is 50 pips and that 1 pip=1$.
From this you position size is 4 Mini Lots or 40000$.
So for you to be able to take this position with the size of your account you would only need 4:1 leverage. Even if we assume that you would have ten positions opened in the same time with the same risk percentage you would only need 40:1 leverage and your total risk exposure would be 20% of your account – not a wise thing to do. So it seems that even with excessive risk you do not need leverage above 40:1. However you state that one should choose the highest possible leverage(400:1). Why? To me this is poor understanding of either leverage or risk management or maybe both.
I will make it even simpler for you Sergiu and for everybody else because that's right, you have the right to question that statement. I did not go into details so here it is:

Let's say you are in a casino. You have found the perfect system and you can predict the outcome of each spin at the roulette table with 100% accuracy.

What is your optimal course of action then?

That's right, bet the MAXIMUM amount of money you can afford on each spin.

Same thing with forex system but to a lesser degree. If your system is a super super perfomer, what is the optimal way of betting (trading)? Well since your system is extremely good and produces almost zero drawdown on each trade (in the worst case scenario each trade goes against you but only 3 to 5 pips before moving in your favor) your optimal course of action is to choose the maximum leverage possible and bet the maxium amount of money possible on each.
It would be foolish to bet otherwise.

I am of of course assuming that your system is extremely, extremely good and that you have found such a beast, I am NOT encouraging anyone to trade like that, this is only a hypothetical example.

It's like a Sci-Fi movie, IF (and only IF) we have the perfect system, what leverage should we always use to milk to forex market?

Note: as always I have ignored (and will continue to ignore) all the personal remarks, they add absolutely nothing to the discussion. Please everyone, if you don't agree with something explain why, demonstrate, convice with some examples, that's the purpose of a forum. The personal stuff is simply boring and will not make your arguments any more convincing, on the contrary.
Sergui, I just re-read my original post there is a huge mistake in it, the

"while still keeping the % of trading balance allocated to each trade under 2% or less" ... to allow for a fast compounding of profits

should of course not be there and belongs to another thread, it just got stuck on my clipboard, terribly sorry for the confusion.

Of course this last sentence does not make sense in this context, sorry again.
Quoting FXTerminator
Let's say you are in a casino. You have found the perfect system and you can predict the outcome of each spin at the roulette table with 100% accuracy.
The chances of predicting the outcome of each spin with 100% accuracy is about the same as predicting the direction of prices with 100% accuracy and those chances are non-existent. So on one hand you are saying that high leverage being bad for traders is a myth. And on the other you are saying that the conditions necessary for that to be a myth do not exist. So which one is it?

Quoting FXTerminator
Same thing with forex system but to a lesser degree. If your system is a super super perfomer, what is the optimal way of betting (trading)? Well since your system is extremely good and produces almost zero drawdown on each trade (in the worst case scenario each trade goes against you but only 3 to 5 pips before moving in your favor) your optimal course of action is to choose the maximum leverage possible and bet the maxium amount of money possible on each.
It would be foolish to bet otherwise.
On your first post you are talking about a 2% risk. Since you have such a “fairy tale” system why do you need 2 % risk? You should be able to risk much, much more than 2%. You are contradicting yourself again.


Quoting FXTerminator
I am of of course assuming that your system is extremely, extremely good and that you have found such a beast, I am NOT encouraging anyone to trade like that, this is only a hypothetical example.
It's like a Sci-Fi movie, IF (and only IF) we have the perfect system, what leverage should we always use to milk to forex market?
First you try to shatter the high leverage myth than you say that the situation where that would be a myth is in Sci-Fi movies. Next, you do not encourage anyone to trade like that in another words, consider the dangers of high leverage, a myth. Which one is it? Seems like another contradiction.
Quoting FXTerminator
Please everyone, if you don't agree with something explain why, demonstrate, convince with some examples, that's the purpose of a forum.
That’s what I am trying to do.
There is a lot more that I would like to communicate to you however I do not see the point since this is probably just going to turn into an useless debate. Therefore this is my last post in this thread.
Good Luck!
Stubbornly persistent
Quoting sergiu
First you try to shatter the high leverage myth than you say that the situation where that would be a myth is in Sci-Fi movies. Next, you do not encourage anyone to trade like that in another words, consider the dangers of high leverage, a myth. Which one is it? Seems like another contradiction.
What I am saying is extremely simple: 400:1 leverage or 10:1 it does not matter, what matters is the margin money you are risking up front in relation to your total trading balance.

If I have $50,000 and I need only $100 to open a position that's good, REGARDLESS of the leverage used. Maybe you are confusing true leverage with the leverage offered by your broker, those are totally two different things.

True leverage means total balance divided by margin money required, period.

The leverage we are discussing in this thread means the number of dollars you can control with X amount of money. If you open a position with $100 and you are now controlling $10,000 worth of currency, that's 100:1 leverage, REGARDLESS of your total trading balance.
Gghaaaa!!!

I can't believe there can be this many threads explaining such a simple topic.

Leverage is... your total position size divided by your account balance.

Margin Utilisation is... the the amount of margin needed to open said position.

That's all there is to it.
Quoting FXTerminator
The leverage we are discussing in this thread means the number of dollars you can control with X amount of money. If you open a position with $100 and you are now controlling $10,000 worth of currency, that's 100:1 leverage, REGARDLESS of your total trading balance.
No, that's margin utilisation. You are using $100 of your margin to control $10 000 at a utilisation rate of 1:100. The above would mean nothing unless it is linked to your account balance. If your account balance is $10 000, that same mini-lot position would represent 1:1 leverage and the corresponding risk would be fairly low. If your account balance is $100 you are leveraged 1:100 and you could be facing a margin call pretty quickly. Your view of leverage has no use unless it's linked to an account balance. That's why the true definition of leverage exists.
F,

Your last 2 posts were brilliant...a little antagonistic...but brilliant!

I knew this was discussed previously, and saw a few of your posts, but it didn't hit me as truth, until your last 2 posts for some reason.

I've been thinking along the same lines for a while, but I just didn't have the vocabulary to describe what I was thinking...thanks for helping me in that department.

Quoting faure
No, that's margin utilisation. You are using $100 of your margin to control $10 000 at a utilisation rate of 1:100. The above would mean nothing unless it is linked to your account balance. If your account balance is $10 000, that same mini-lot position would represent 1:1 leverage and the corresponding risk would be fairly low. If your account balance is $100 you are leveraged 1:100 and you could be facing a margin call pretty quickly. Your view of leverage has no use unless it's linked to an account balance. That's why the true definition of leverage exists.
i agree with FXTerminator that the leverage on your account really doesnt make a difference. its up to you to decide how much you will risk. lower leverage keeps you from going crazy though

as far as risking all of your account leverage, well thats crazy . you should risk as much as your system allows, no less, no more (i know that is vague but thats a different episode )
Quoting mrmikal
F,

Your last 2 posts were...a little antagonistic
I'm sorry for that. It kinda burst out of me.

Quoting mrmikal
I knew this was discussed previously, and saw a few of your posts, but it didn't hit me as truth, until your last 2 posts for some reason.

I've been thinking along the same lines for a while, but I just didn't have the vocabulary to describe what I was thinking...thanks for helping me in that department.
No problem hey! Glad I could help.
Quoting FXTerminator
Here is a another typical trading myth: high leverage is bad for you! You see this idea in every futures/forex forums over and over again.

This is of course total nonsense and here is why.

Each time you open a 100 to 1 (or more) leverage position in a forex mini-account, your friendly forex dealer is simply saying this : "Hey Mr. Trader, just put $100 in your account plus cost of spread and I will let own $10,000 worth of currency, and if the market moves just 1% in your favor you make 100% profit on your margin money, less cost of spread and a possible small interest!"

so I guess if you have a 100K account with 100:1 leverage offered and you make $1000 dollars over the course of a year, you would say that you made 100% in that year - bravo - I can now tell my family that even though they are only up 15% for the year, they really are up 1500% on their "margin money". What is the use of that logic.

This "high-leverage-is-bad" myth is based on a simple confusion : most traders, newbies (and some pros alike!) assume that leverage means your total trading balance divided by the value of your position.

Actually it is your trading position divided by your balance. I can see why you are confused.

Your trading balance has of course NOTHING to do with leverage!

????

It does not matter if your trading balance is $1,000,000 or $100, if you open a position and you only need $50 to own/control $10,000 worth of currency then you are trading with a 200:1 leverage, period.

Remember this for later response highlighted in green

So high or low leverage, it does not matter. HOWEVER, what is really, really important is the percentage allocated to each trade. If you open a forex position and you need $5000 margin money and that margin money represents 100% of your trading balance then "Houston we've got a problem" indeed, no doubts about that.

In fact, if a trader has an excellent forex trading system, then the optimal course of action is to choose the highest leverage possible (400:1), to allow for a fast compounding of profits.

according to you in the earlier example you are trading with 200:1 leverage even though your account is 1,000,000 and you are trading 1 10K lot(meaning trading with leverage has nothing to do with account balance, according to you). If that is the case, then trading with 400: leverage wouldn't make a difference if your balance was 1,000,00 as well - you would still be trading 1 10K lot by this logic only your margin necessary per lot would be less. Either way you are trading 1 10k lot so how is 400:1 in this scenario compounding your profits any more. Do you now see the folly in your thinking.

PS: this thread is NOT an invitation to trade with higher/lower leverage, as always trade at your own risk.
-
Man who scratches ass should not bite fingernails
I didn't understand your first few comments.

I think Faure explained it best. It's similar to a few themes in your post.

Anyone else want to beat up on FXT? LOL...I think for the most part, everyone is in agreement...there is a difference between maximum leverage and trading leverage (which has already been explained twice as the amount of currency controlled in your trading position divided by the size of your account). FXT is in somewhat of an agreement in that the 400:1 versus 50:1 leverage makes no real difference when it comes to determining your actual leverage.

Quoting Leugimp
-
Quoting faure
No, that's margin utilisation. You are using $100 of your margin to control $10 000 at a utilisation rate of 1:100. The above would mean nothing unless it is linked to your account balance. If your account balance is $10 000, that same mini-lot position would represent 1:1 leverage and the corresponding risk would be fairly low. If your account balance is $100 you are leveraged 1:100 and you could be facing a margin call pretty quickly. Your view of leverage has no use unless it's linked to an account balance. That's why the true definition of leverage exists.
So let's say I open a forex position with $100 (that's ALL I have in my account) and I now control $10,000 worth of currency. What is the leverage?

Right, 100:1

Now let's say I tell you this over a beer: "Hey Faure, you know what, I have $10,000 dollars just sitting and collecting dust in ANOTHER forex account with ANOTHER forex broker".

Now you mean to tell me that NOW my leverage is not 100:1 ANYMORE but 1:1 simply because I told you that I have $10,000 somewhere else ??? Come on! What if I tell you that I lied, that the $10,000 is in the cookie jar in my kitchen instead, am I still trading with 1:1 leverage according to you?

Leverage has NOTHING to do with your trading balance, nothing! It simply means how much money you can control with X amount of money, period. How much money you have in your FX account, your bank account, your mattress or your attic has nothing to do with leverage, nothing.

This is what FX is all about: "Give me $100 and I will let you own $10,000 worth of currency (100:1 leverage)". How much money is ALREADY in your FX account or how much money you INTEND to wire to your FX account each week/month is totally irrelevant.
Quoting FXTerminator
So let's say I open a forex position with $100 (that's ALL I have in my account) and I now control $10,000 worth of currency. What is the leverage?

Right, 100:1

Now let's say I tell you this over a beer: "Hey Faure, you know what, I have $10,000 dollars just sitting and collecting dust in ANOTHER forex account with ANOTHER forex broker".

Now you mean to tell me that NOW my leverage is not 100:1 ANYMORE but 1:1 simply because I told you that I have $10,000 somewhere else ??? Come on! What if I tell you that I lied, that the $10,000 is in the cookie jar in my kitchen instead, am I still trading with 1:1 leverage according to you?

Leverage has NOTHING to do with your trading balance, nothing! It simply means how much money you can control with X amount of money, period. How much money you have in your FX account, your bank account, your mattress or your attic has nothing to do with leverage, nothing.

This is what FX is all about: "Give me $100 and I will let you own $10,000 worth of currency (100:1 leverage)". How much money is ALREADY in your FX account or how much money you INTEND to wire to your FX account each week/month is totally irrelevant.

You just dont get it scott do ya

I'm gonna place him in an easily escapable situation involving in overly elaborate and exotic death.
Man who scratches ass should not bite fingernails
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