Way too much time is spent worrying about leverage.  Traders sweat over questions like “Do I have enough leverage?”, “How can I take the most advantage of my leverage?”, and “Do I have too much leverage to be safe?”  Not that these aren’t important considerations in their own light, but the truth is a prudent trader never needs to worry about leverage.

Why?  Because even a ‘low leverage’ trading account – with, say, 50:1 leverage is more than you should ever need.  If you follow a reasonable risk management strategy you will have plenty of headroom to play with.  Let’s start with a quick summary of what leverage is.

Margin (sometimes referred to as leverage) is when a broker lets you buy (or sell) more currency than you actually have money for.  If you have 50:1 leverage, you can buy $50 of currency by using only $1 of your account balance.  This gives you the ability to make far more money than you otherwise would be able to if you had no leverage, but it also makes it possible to lose far more money if your trade decisions don’t pan out.  Likewise, if you have 200:1 leverage (I’ve seen as high as 500:1) you can buy $200 of currency with your $1 of account balance.  Basically you’re borrowing the extra money from the broker (which leads to interest rate charges, which I’ll cover in another post).  They’re not at risk, though, because they have full control of your trading positions.  They will close your trades for you if you incur enough loss to wipe out (or come close to wiping out) your account.  This is called a margin call.  If you trade correctly, you will never have a margin call.  Avoid them at all cost.

Now let me explain why you need not worry about margin with a quick trip to Forex School:  You should set the size of your trades as a percent of your balance – typically 5% maximum – and that ensures that you will never risk so much money that you will be in danger of a margin call, and therefore you have no need to be concerned about leverage.  Here’s an example.

Your balance is $5,000.  You want to risk 3%, which is a risk of $150.  When you decide to make a trade, you should select a stop loss which makes sense in the current market.  That is, you need to choose a price which tells you “You made a wrong decision, get out!”  When the price hits that point, it no longer makes any sense to stay in your trade and you should close the trade immediately.  Now, size your trade so that you will lose no more than $150 if that stop loss price is hit.  If you choose 100 pips for a stop loss in EURUSD, you will size your trade to be equal to $1.50 per pip.  That works out to a trade size of .15 mini-lots.  That’s all you should trade.

Since a mini-lot is worth $10,000 you have a total trade value of $1500.  Since you’re only paying 1/50 of that amount (50:1 leverage) your account will only see a hit of $30 to enter this trade.  You have $5,000, so obviously you’re not coming close to running out of money even with a low margin account.  So much for worrying about not having too much.  Now consider what happens if you have a high leverage account of say 500:1.  This is no greater risk, because the risk you take is based on how large your trade is and how wide your stop loss is.  These values have nothing to do with your leverage, so having a high leverage account does not equate to having a higher risk.

So, in summary, the key to controlling your trading and maintaining safety is to plan your trades prudently, with a known risk amount.  When you do this, you find that forex margin is essentially irrelevant.  If you’re running out of leverage, you’re trades are too large.  If you are at high risk in a high leverage account, again it’s because you’re trades are too large.  Make a prudent plan and stop worrying about margin.