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High leverage -> high risk: Please explain

  • #1
  • First Post: Mar 10, 2013 6:40pm Mar 10, 2013 6:40pm
Hello Trader community,

a statement that I ask again and again for many month, because in the forums it is very often written by a high risk of leveraged investment products.

I only trade Forex in my feetime, just for fun.

what makes it different, if I use a leverage of 100 or 400, the difference is clear to me:

If I take a trade, 1 lot of EUR/USD with a leverage of 400, I have to give a lower amount of margin to my broker as I would using a leverage of 100.
The margin I always get back from by broker, if I use stop loss limits.

so I can determine or calculate my risk by my margin requirement as a basis.

or in other words:
if a EUR/USD trade brings me 50 pips, volume of 1 lot, I have a profit of $500
whether I am using a leverage of 1 or 400, my profit is always 50 pips/$500

or the trade should be stopped out by my SL (eg. RRR = 1), which means I have minus of 50 pips/minus $500.
whether I am acting with a leverage of 1 or of 400.

Can someone explain this "panic-thought" in public space?

So why a higher leverage should be a higher risk? (Im talking about absolute risk and not relative risk)



greetings, forexmaster.
(in your replies please do always use examples with a lotsize of 1)
  • #2
  • Mar 11, 2013 2:08am Mar 11, 2013 2:08am
From my understanding the reason people refer to using higher leverage as having higher risk is because people are using that higher leverage to open larger positions with the same amount of margin.

For example lets say you have 1:100 leverage and you are able to open a 1 lot position and 10 pips are equal to $100, now you double your leverage to 1:200 and open a 2 lot position with the same amount of margin. 10 pips are now worth $200 and you have essentially doubled your risk.

You say in your post to only refer to a 1 lot size position. In regards to a 1 lot size position the risk will always be essentially the same because you are always using the same lot size.

I hope this helps answer your question.

If anyone has anything to add or correct please do so.
  • #3
  • Mar 11, 2013 2:59am Mar 11, 2013 2:59am
Hey Forexmaster.

Higher leverage = Higher risk -> This is a FACT! The reason why you don't understand it is because the leverage you are talking about is actually only your margin requirement to open a trade. From your post you do understand this concept, but this is not real leverage. So why is it called leverage by brokers in the first place? In my opinion it's to confuse all new retail traders. So that they do not know what their real leverage is and therefore take on too much risk, resulting in many blown accounts.

So what is "real" leverage?

It is your position size divided by your account size.

Example:
Lets say you want to trade 1 lot in EUR/USD. That is a position size of $100 000. To trade at 1:1 leverage, your account size needs to be $100 000.

Lets say you only have $20 000. Your leverage to trade 1 lot is now 100 000/20 000 = 5. That is a leverage of 5:1.

Lets say you have $400 000. Your leverage to trade 1 lot is now 100 000/400 000 = 0.25. That is a leverage of 0.25:1.

So why is it riskier to trade with high leverage?

Lets look at the above examples again.

You have a $100 000 account. and you open a position with 1 lot. That is $10/pip. Your leverage is 1:1. To blow your account, you need to lose 100 000/10 = 10 000 pips.

You have a $20 000 account. and you open a position with 1 lot. That is $10/pip. Your leverage is 5:1. To blow your account, you need to lose 20 000/10 = 2 000 pips.

Do you see the difference "real" leverage makes?
  • #4
  • Mar 11, 2013 3:23am Mar 11, 2013 3:23am
Quoting PiptheRipper
Hey Forexmaster.

Higher leverage = Higher risk -> This is a FACT! The reason why you don't understand it is because the leverage you are talking about is actually only your margin requirement to open a trade. From your post you do understand this concept, but this is not real leverage. So why is it called leverage by brokers in the first place? In my opinion it's to confuse all new retail traders. So that they do not know what their real leverage is and therefore take on too much risk, resulting in many blown accounts.

So what is...
aaaaand you completely missed the OP's point.

people, not unlike yourself, get all uppity and jump about when they hear broker xyz offers n:1 leverage, because according to their busted reasoning the leverage available on an account somehow matters. the risk on any trade has little to do with the 'leverage' an account offers a client.

the OP nailed it. the % of your account at risk is what matters, and has nothing to do with the so-called leverage available on an account.

you've differentiated between account leverage with position leverage. others don't tend to do this. and besides, talking about position leverage is really just making a mess of things when it would be clearer to speak in terms of % of account at risk, as the op has. what value does position leverage have if you don't take into account the stop distance, and hence the actual amount at risk?

edit : the goal is to be balls-deep in a position leveraged to the max... with zero of your account at risk.
Congratulations ScalaFX for coming out of the closet!
  • #5
  • Mar 11, 2013 3:39am Mar 11, 2013 3:39am
Quoting nubcake
aaaaand you completely missed the OP's point.

people, not unlike yourself, get all uppity and jump about when they hear broker xyz offers n:1 leverage, because according to their busted reasoning the leverage available on an account somehow matters. the risk on any trade has little to do with the 'leverage' an account offers a client.

the OP nailed it. the % of your account at risk is what matters, and has nothing to do with the so-called leverage available on an account.

you've differentiated between account leverage with position leverage....
Yeah alright reading that again makes more sense now. Thanks for pointing that out. I also agree that it's the percentage at risk which is the most important factor regardless of leverage. Leverage can be increased without increasing risk.
  • #6
  • Edited 5:16am Mar 11, 2013 3:46am | Edited 5:16am
.
From a different point of view:

Leverage is "credit". Measured in "times" the amount of deposit.
If your deposit is $1 and the Brokers give you credit 1:100 ( 100 times your deposit) you can buy
up to 100 units of currency of your deposit currency. If they give you 1:400 you can buy up to 400
units.

So, like any type of credit, nothing wrong to have a lot of it. But the use of it s could be dangerous.

For example, if you earn 50K a year and a Bank grant you a credit card for a max of 50k, it is
not wise to max it out, right? If something goes wrong like losing employment, sickness, etc
most likely you would be in trouble. Same thing with this credit to buy currencies. If we "use"
too much of it for impulsive purchases and all of a sudden something goes wrong, like gaps or thing of that nature
that our stops will not be respected, we can end up in trouble and losing more then we wanted.l

regarding your question.."So why a higher leverage should be a higher risk?"
Your assessment is quite correct, the risk incurred in a certain trade has nothing to do with the leverage
"provided" by the Broker. But any trade can be measured in leverage "used" in relation to the deposit,
so that is what is referred as dangerous. Leverage of 1 of your deposit mean you basically are not using credit.
If you have 20 000 deposit and purchase 20 000 units you are just using all "your money". If you buy
40 000 then you are using 2 leverage, or 60 000=3 leverage, etc. . That is the number we should keep in check.
The number of times yo get in debt according to your own deposit.
J.
  • #7
  • Mar 11, 2013 6:23am Mar 11, 2013 6:23am
Trading using leverage carries a high degree of risk to your capital, and it is possible to lose more than your initial investment. Only speculate with money you can afford to lose.

High leverage = high risk because you can theoretically lose more than the money you deposited in your account.

Don't forget that brokers have automatic systems in place to force liquidation of your position before the leverage make you lose more than 100% of your account, but you're still liable in the event of a problem occurring during the liquidation process and your account goes into debit, hence the high risk of losing more than what you put into the account.

This can't happen if you don't use leverage, because you could then "only" lose 100% of your account but NOT more.

There's nothing wrong with leverage if you manage risk correctly and use it wisely.
The biggest problem could arise when volatility and emotions start to come into the picture, then leverage (or too much of it) can cause emotional errors that quickly escalate to magnified losses...
Getting it right is NOT as important as not getting it wrong.
  • #8
  • Mar 13, 2013 9:04am Mar 13, 2013 9:04am
Dear Forexmaster

I am new to this field. Can you please clear me what "using a leverage means in trading?" I have seen this term before but not clear what it actually means!

Thanking you in anticipation.
  • #9
  • Mar 13, 2013 9:29am Mar 13, 2013 9:29am
Quoting Red Herring
Dear Forexmaster

I am new to this field. Can you please clear me what "using a leverage means in trading?" I have seen this term before but not clear what it actually means!

Thanking you in anticipation.
Hi red Herring,
Leverage: Using borrowed capital to increase your returns from an investment.
Simple explanation: You land a good deal- lets say computers at $200.
You know that you will sell the machines for $300 profit in your market.
In your pocket you got only $2000(enough to purchase 10 machines only)
You figure out that the profit is too small and decide to borrow $10000 )
on condition that you invest your $2000) from a friend to buy more pieces. STOP
Your Friend who lend you $10000- gave you a leverage of $10000(loan) and required you to have
$2000(margin) of your own money.

Same thing in trading; the broker gives you a leverage on a certain margin( a certain percent of the money must be yours) when you make profit and
close the transaction, you take all the profit including what you made using the borrowed cash. If you lose, the broker deducts (his lost money) from your balance./

I hope it is clear now..
Danny
  • #10
  • Mar 15, 2013 11:45am Mar 15, 2013 11:45am
Thanks Danny

You taught like a teacher. I got it clearly. Its a facility provided by the broker.
  • #11
  • Mar 15, 2013 12:39pm Mar 15, 2013 12:39pm
Quoting forexmaster

Can someone explain this "panic-thought" in public space?

So why a higher leverage should be a higher risk? (Im talking about absolute risk and not relative risk)



greetings, forexmaster.
(in your replies please do always use examples with a lotsize of 1)
it's simple. the higher leverage you use the more you can earn/loose with same account balance.
for example. with 1:50 you can afford to buy 1 lot - with 1:500 - 10 lots. If you buy only 1 lot it makes no difference if your leverage is 1:50 or 1:500, you will loose same amount of money. but if you'll buy 10 lots, you loose/earn much more

also - let's say you invested 100% of your balance.
at 1:50 20 pips of loose will be around 7% of the balance
at 1:500 20 pips will mean a loss of about 70% - makes a difference - doesn't it?
high leveraged accounts are not for fools, but a lot of fools use them.

personally I stick to 1:50 and will go for higher lev. just because I am curious
On my way to financial independence - if others can do it - I can do it
  • #12
  • Mar 15, 2013 12:40pm Mar 15, 2013 12:40pm
Nice exp, and yes, high leverage=more risk, always.
This is why you need to rethink your account size, leverage and margin when opening positions
  • #13
  • Mar 15, 2013 12:49pm Mar 15, 2013 12:49pm
Leverage is simply how much of your account is held by your broker for each trade.

Think of it as a buffer / escrow account between you and your broker.

If you use 1:20 leverage and place a trade, then you have to give a large percentage of your account to the broker whilst that trade is open. This is good because it means you can't go batshit crazy and open up dozens of trades, as money is now held by your broker.

If you use 1:500 then you only give a tiny percent of your account to your broker, so you can go full-tilt and open shit loads of trades with big lots....but beware, this is how you can lose money fast.

This is why they offer huge leverage to retail as they prey on your emotions to chase losses and add to losers etc, by compounding drawdown, before you know it.....margin call territory.

There is nothing wrong with using big leverage if you understand the above; why not use borrowed money factored out of thin air, just don't load the boat with losses else your account will be wiped after the next market heartbeat.
Politics is the womb in which war develops.
  • #14
  • Mar 15, 2013 1:11pm Mar 15, 2013 1:11pm
Quoting forexmaster
Can someone explain this "panic-thought" in public space?
Forexmaster,

In short,
higher leverage account allows you to buy more, a lot more for less money but leaves room for your net lost.
It also give you chance to flip your account.

In investment business, that's called HIGH RISK

High leverage account opens the door to high risk invest, but the choice is still in your hand.

So you are right,

Risk wise, with correct risk management on every trade, say 2% account size on each SL order, 1:50 and 1:400 is really no difference IF TRADE STOPS OUT.
More than a hobby. Never a game. US Client at 1:50.
  • #15
  • Mar 16, 2013 7:00pm Mar 16, 2013 7:00pm
Quoting Cree

You say in your post to only refer to a 1 lot size position. In regards to a 1 lot size position the risk will always be essentially the same because you are always using the same lot size.

I hope this helps answer your question.

If anyone has anything to add or correct please do so.
Well said, and that's correct, if you always look after the LOT SIZE according to you risk management, leverage does not make much difference as long as your free margin will be able to hold your negative balance.
More than a hobby. Never a game. US Client at 1:50.
  • #16
  • Mar 16, 2013 7:23pm Mar 16, 2013 7:23pm
Quoting fxswing


and it is possible to lose more than your initial investment.

Don't forget that brokers have automatic systems in place to force liquidation of your position before the leverage make you lose more than 100% of your account, but you're still liable in the event of a problem occurring during the liquidation process and your account goes into debit, hence the high risk of losing more than what you put into the account.

This can't happen if you don't use leverage, because you could then "only" lose 100%...
After I read your reply post, from the statements I picked out above, i am sorry to say there could be errors within your understanding towards leverage and margin call.

Firstly, leverage would only expose you to a greater risk because it allows you to buy more. Once your negative balance reaches margin leve, yes, borker will close your positions, but ALSO give back your margin money to continue for the next trade.

So your will NEVER lose more than your account because there will be always margin call and then you will have the margin money from pervious trade to continue trading further on.

Secondly, in this high risk forex business, broker must have the system to NEVER let their investers to lose more than what they put in, right?

I am not sure which area you are coming from, but in US after I killed countless live and demo accounts over the years, i think i know how leverage from 400:1 to 50:1 (currently), margin, and margin call works.

But please pardon me for my straight thoughts.
More than a hobby. Never a game. US Client at 1:50.
  • #17
  • Mar 16, 2013 8:16pm Mar 16, 2013 8:16pm
Quoting Red Herring
Dear Forexmaster

I am new to this field. Can you please clear me what "using a leverage means in trading?" I have seen this term before but not clear what it actually means!

Thanking you in anticipation.

Red Herring,

On top of what Danny said,

Says you are wating to invest in Share ABC with HALF of your $100 total capital, $50, and you want to choose from

Broker A with 1:1 leverage
Broker B with 1:10 leverage.

Broker 1 with 1:1 leverage
With broker B, depoist $100 at 1:1 leverage
You may purchase ONLY 1 share of Share ABC ($50 x 1 share= $50) at a price of $50 per share, and that leaves you remaining $50 on hand.

Broker 2 with 1:10 leverage
With broker B, depost $100 at 1:10 leverage
Share A price reduced to 10 times smaller because 1:10 leverage, $5 per share, and you may purchase 10 shares of Share ABC ($5 x 10 shares = $50), and leave your $50 on hand, too.

When share increase $1, you would received profit,
Broker A, $1 x 1 share = $1
Broker A, $1 x 5 share = $5

This is so called "the power of leverage"


Now here comes the tricky part when it comes to Lose,

Both broker will FORCE to close your position when your account lost the other $50 you had after putting down the first $50 purchasing Share A. This is also called Margin Call. It is also very important to understand that after Margin Call, both brokers will give back the $50 you used to purchased Share ABC to continue to invest. In this example, you will still have total $50 to invest the next one after you received the Margin Call from both brokers.

And Here is how the calculation goes,

Broker A with 1:1 leverage who you purcahsed 1 share of Share ABC from
$50 / 1 Share = $50 points worth of drop

Broker B with 1:10 leverage who you purchased 10 shares of Share ABC from
$50 / 10 shares = $5 points worth of drop

In this case, Broker B expose you to your margin call 10 times quicker compare to Broker A.

My option on leverage is that it is a two-edage sword, and you must use it wisely.

If i have missed anything, please point it out. Thanks.
More than a hobby. Never a game. US Client at 1:50.
  • #18
  • Mar 16, 2013 8:18pm Mar 16, 2013 8:18pm
Quoting FiatFap
Leverage is simply how much of your account is held by your broker for each trade.

Think of it as a buffer / escrow account between you and your broker.

If you use 1:20 leverage and place a trade, then you have to give a large percentage of your account to the broker whilst that trade is open. This is good because it means you can't go batshit crazy and open up dozens of trades, as money is now held by your broker.

If you use 1:500 then you only give a tiny percent of your account to your broker, so you can go full-tilt...
right on the bull's eye.
More than a hobby. Never a game. US Client at 1:50.
  • #19
  • Mar 17, 2013 7:45am Mar 17, 2013 7:45am
My concept is choosing high leverage don't mean taking high risk. Leverage increases the capability of trading. Suppose I have $1000 and I am using 1000:1 leverage so it is possible for me to but 10 lot. So only 10 pips gain (except spread) will bring your 10% gain that means $1000. But if we think the negative side only 10 pips loss cause you to loss 10% of your capital. Also you will face loss with less than 100 pips loss.
But it is not necessary that I am choosing the big leverage for its maximum use. I think most important is how much risk I am taking. If I take only 2% risk using high leverage and with proper sl then it will be no problem whether I am using high leverage or not.
So I always choose the maximum leverage and it is because sometime we get very strong signal and I want to maximize my profit that time.
Never test the depth of water with both feet.
  • #20
  • Jul 16, 2014 12:20am Jul 16, 2014 12:20am
All of the post above we we constructed. I simple would like to add one thing..

There is a massive difference "to me at least" between "Your risk" and what you are actually "risking".

What you are risking of course would be margin. The amount of money locked into a position in order to keep it open.

Your "risk" would be your actual exposure to the market. Such as your sl, if you are prone to revenge trading, and the accuracy of your system.


Most people frown upon using high leverage + high equity as it could result in a quicker loss of your account compared to using small amount of funds.
Banks scalp, why don't you?
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