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How to Calculate Leverage? TOP-7 Facts You Didn’t Know!

How to Calculate Leverage? TOP-7 Facts You Didn’t Know!
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Contents:

1. Fact #1. How Does Leverage Work and Why Is Margin Trading Needed?

2. Fact #2. Sizes of Leverage

3. Why Does a Broker Give a Loan for Us?
3.1. Fact #3. How DO Forex Brokers Make Money? What is Margin Call?
3.2. More Information about Stop Out Execution or What is Leverage in Action?

4. Fact #4. Other Costs of Leverage

5. Fact #5. Binary Options and Leverage

6. Fact #6. Leverage Is Evil or Leverage Is Good? Myth of the Harm of Big Leverage!

7. Fact #7. Controlling Risks While Trading with Leverage
7.1. Method #1! Never Trade with the Maximal Amount!
7.2. Method #2 – Set StopLosses – Protect your Orders!

8. How to Calculate Leverage: the Conclusion

Leverage is the indispensable part of the Forex market. It is set up automatically depending on the volume you are to trade with. Speaking simple, leverage is the ratio between your deposit and trading amount. So, having $100 in disposal, you may make an order of $10,000. In such case, your leverage will be 1:100. In recent time, most novices are wondered: how to calculate leverage? And they have this question emerged while already trading at the real account!

 

Let’s start with the fact the Forex market is the international interbank currency market, where banks and other major players are the main participants. Everyday volumes of trading at the market exceed 6 trillion dollars! Just to compare, everyday volumes of trading at the world greatest stock exchange – NYSE Euronext reach 200 billion dollars. Forex market is the most liquid exchange of the world, and trading amounts are enormous there. To make one order, a trader needs at least $1,000. And not everybody has such considerable amount in the pocket! Especially, a novice. That’s why forex brokers offer leverages. Yes, most write: Forex is a fraud, leverage is evil, never increase its level – keep it at 1:100, etc. Let’s figure everything out!

 

Fact #1. How Does Leverage Work and Why Is Margin Trading Needed?

First, leverage is the financial instrument which allows a trader to operate with solid money – more than they really have in disposal. But, if a trader is not prepared, they can suffer big losses.

For example, I have the deposit keeping $5,000 and I plan to work with one trading lot at the order. In fact, I use $100,000 in my operation. Though, I have only 5,000 at the deposit.margin trading

So where do I get the rest amount, you may ask? $1,000 is taken by me as a guarantee. The rest, $99,000, are provided by the broker, as a credit margin. And this is the key attraction of Forex market – and it’s as dangerous and avid. Most people enter the market with the extremely low amount with the hope to make money fast. But, as a result, they waste everything. The main reason lies in the fact that one cannot struggle themselves, they don’t follow their strategy.

 

Fact #2. Sizes of Leverage

 

Let’s talk about the size of leverage. Today, there is the plenty of companies at the market, which offer different leverages, beginning from 1:100. Some, especially, new brokers, offer even 1:2,000. It’s too much, as far as I am concerned. At Forex, for instance, standard leverage is 1:100, and maximum seen by me was 1:5,000. At the stock market – standard leverage is 1:5, while maximum reaches 1:20. And it goes with the fact major funds don’t use leverage at all – they work 1:1. What is leverage? Dear readers, make your own conclusions: clever hands don’t fear working.

 

Why Does a Broker Give a Loan for Us?

 

Now, let’s talk about why does a broker give us leverage and how do they protect their money. Forex market is the big business, and participants make money their own way. You may ask “how to calculate leverage?” It is a loan, if fact. It increases volumes and different expenses related to the order.

 

Fact #3. How DO Forex Brokers Make Money? What is Margin Call?

 

Brokers make money with:

  • Fees for trading lots;
  • Spreads (they can be market-dependent and fixed): market-dependent always changes, but at the average, it is of 0.4 pips, while fixed is always static;
  • Swaps – they depend on the interest rate of the Central Bank (Federal Reserve);
  • Fees for money transfer and so on.

forex brokersWhat’s to the issue of losses of brokers, it’s quite simple to be figured out – brokers never suffer losses! Let’s imagine a situation: I opened an order of 1 lot, the market made a sharp turn by words of, for instance, Mario Draghi, and I started losing money momentarily. When my deposit fell to $1,000 (I had $5,000 in the beginning), the broker closed my trade automatically. It’s Margin Call (or Stop Out). So, examining the problem “what is margin call”, we may interpret this term as a call to the customer about the order. Today, in the 21th century, brokers don’t call their customers, as it was 20-30 years ago, but automatically close the position. So, that’s how that clever brokers protect their funds!

 

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More Information about Stop Out Execution or What is Leverage in Action?

 

So, funds on my account: 5,000-4,000 = $1,000. That’s it: when the deposit falls to the certain level (in our case, to 20%), an automatic Margin Call takes place. Every company has its own terms, they all have different levels of margin call, but at the average, it fluctuates between 20% and 50%. So, when the deposit approaches to, for example, 20%, the order is closed automatically.

Let’s look into details. My loss was equal to $4,000. The initial guarantee was $1,000, $99,000 were added by the broker as a loan. We have: $99,000 + $1,000-$4,000=$96,000. Remember forever, a broker is always in profits! In this case, they take lacking $3,000 from the customer (me). So, in total, I have remaining $1,000 only as a result of losses.

In case of making money, everything is converse. All the profit is mine! Let’s take I earned $8,000: margin is still $99,000, $1,000 is made of guarantee. When the order is closed, I have remaining $108,000. From them, $99,000 are taken by a broker, returning their margin this way. As the same time, I take back my guarantee of $1,000 and get net profits of $8,000.

 

Fact #4. Other Costs of Leverage

How to calculate leverage and what is it? It is also the catalyzer for other costs – only few know about it! Each Forex order is opened for the certain amount and leads to some costs, such as spread, swap and fees. It turns that the higher is leverage, the higher are your costs, and you need to make money in order to cover them, and your incomes should be stable! Let’s imagine a situation: one registers, uploads documents and opens a trading account. Then, for instance, they think of opening a “long” – 10 lots of GBP/USD with a spread of 2.5 pips. To purchase, they use the whole potential of 1:100 leverage. Multiply $10 per pip by 2.5 pips of a spread and by 10 trading lots. Totally, a trader is in negative balance initially for $25 per lot! So, they pay $250 for 10 lots when entering the order, losing almost 2.5%. In order to cover losses of the order, a trader needs to close the spread first, and only then to make money.

 

So, that’s how margin trading looks like! It can make you wealthy in a moment, and in a second you can lose everything. Therefore, dear colleagues-traders, especially novices, don’t take risk at everything you have! Use the money-management: I would advise you first to work with low amounts, risking with 1% per order. Yes, I repeat, 1%! You won’t gain too much, like in an ad, with super cars and girls (at least, you won’t make it fast). But the most significant thing for a trader is to save money first, and only then to gain money, if the market allows to, and it does! Every day! So, pals, work and work harder – the world is your oyster!Einstein quotes

 

Fact #5. Binary Options and Leverage

What’s to binary options, this instrument has appeared quite recently at the market. But more than half of brokers all over the world have already included it in their arsenal. They are also called digital options, all-or-nothing orders or just fixes. Trading this instrument was officially started in 2008, first – at the AMEX (American Stock Exchange) and CBOE (Chicago Stock Exchange), and then throughout the world. Few words about leverage: options doesn’t have such! Orders in options are provided by the basic asset, which is set as a risk by a trader. In case of growth, a trader gains, in case of fall, a trader loses the asset-bet. That’s why you won’t have to think over the problem “what is margin call”. Simplicity and high profitability are the main advantages of options! More information about ways to make money at the market of derivatives can be found in the article “The Step-By-Step Instruction for Trading”.

 

Fact #6. Leverage Is Evil or Leverage Is Good? Myth of the Harm of Big Leverage!

For example, we have two trading accounts: the first one with the leverage of 1:100, and the second one with 1:500 leverage. We open similar orders of 0.02 pips each. Beginners often ask a question which account leads to higher risk. I can answer that risks are absolutely equal in both cases!

Imagine that we got a stop loss of 100 pips for both accounts with the order volume of 0.02 pips. Losses in this case will be $20. But doesn’t loss amount become higher with the increase of leverage from 100 to 500, you may ask. No way! Actually, leverage is created for those who open great orders with low deposit. This way is chosen either by gamers or by professional speculators having awesome trading experience. If you are an adequate trader and use leverage of 1:100 or 1:500, having the system of deposit management, then your losses remain the same. And if you are extremely avid and want some adrenaline buzz, trade with leverage and get stop out – margin call. Situation with leverage looks like “Star Wars” movie: power is art in good hands, and the dark side in bad.

 

Fact #7. Controlling Risks While Trading with Leverage

 

Being asked “how to calculate leverage?”, one has to examine such a component as risk-management. There are two ways that will prevent you from wasting deposit for sure! And the main thing in this business is to sty afloat, and only then to gain.risk-management

Method #1! Never Trade with the Maximal Amount!

The majority of beginners don’t realize the answer to the question “what is leverage”. They think they may come and make some easy and fast money. So, it won’t be so! At least, not that swiftly! Don’t play all-in, like in casino! Currency exchange is the serious stuff, and you should have clear and strict trading system including deposit management, trading strategy, discipline and plan of the workday. Generally, everything must be formalized. Otherwise, you won’t get it! The best win it is the jungle law! Remember that!

Method #2: Set StopLosses - Protect your Orders!

Talking simple, StopLoss is the protective order, which I recommend to use in each and every order, especially for novices. Returning to the example with $5,000-deposit, I make it clear. Stop out worked in that example, and we had $1,000 remaining. If I had set the protective order, I would have lost by far less, and covered those losses the following day. Another thing to remember: a trader always has tomorrow! Remember: stop out is the protection of the last level, the protection of the broker; and StopLoss is the protection of the first level – your protection, which must be used by you! I repeat: in each and every order!

Let’s make the analogy with boxing. For example, you are a boxer – you train every day, having your own tactics of the fight, your feelings. So, let’s suppose you begin yielding in some moment during the fight, giving up without strong protection. As a result, a couple of hits were missed, and there is a knockout. Your fight is over! The same is with Forex: a couple of “price hits”, and your deposit gets a guaranteed knockout. So, protect your orders – set StopLosses!

 

How to Calculate Leverage: the Conclusion

Dear readers, if you really want trading to become your job, you must know and realize everything. What is leverage, spread, swap, fees, slip, requotes, gaps, terminal, trading instruments, etc.!

But, what can we conclude from everything that was discussed?

  1. Leverage is the credit leverage, which is provided by a broker in the certain ratio – usually, 1:100, to allow a trader to operate with high volumes.
  2. One may trade without leverage, if their deposit bears more than $50,000. If a more humble amount is on the account, less than $1,000, then you will have to engage margin trading.
  3. Leverage higher than 1:200, 1:500 and more leads to extreme risks of fast wasting of the deposit, if, of course, you use it for 100%.
  4. The higher is leverage, the higher are profits of successful orders, and conversely.
  5. In order to make stable incomes at Forex market, you must have your own trading system and strictly follow it every day. Without deviations!
  6. To minimize your losses, even if you don’t trade with high trading leverage, properly set your protective order preventing you from wasting everything.
  7. There is no leverage in binary options – you take risk only with money invested in the order! So, being asked “how to calculate leverage”, think – maybe you have to get on with binary options better?
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