Leverage in Forex? The Forex market is known for having certain characteristics that are different from other markets , such as its high liquidity, its opening hours (open from Monday to Friday continuously) and its leverage. In the Forex market we can even operate with a leverage of 1: 500, depending on the broker, this means that for every euro we have in our account we can move up to 500 euros in the market. That is, that leverage, for those who do not know it yet, is the relationship between equity and credit.
How do we calculate leverage in Forex?
First of all, it must be made clear that leverage is not the margin, concepts that are often confused. Margins are the money that the broker uses from our account to open a trade, while leverage, as we explained before, is the relationship between equity and credit.
And how do we calculate leverage?
Very simple, dividing the nominal of the operation that we have open , or operations that we have open if there are more than one, with our invested capital.
For example, imagine that we have an account of 5,000 and that the total nominal of our operations in the Forex market is 100,000.
The calculation would be as follows: leverage = (Nominal of operations) / (capital of our account) = 100,000 / 5,000 = 20.
Our leverage would be 1:20, that is, for every euro we take into account, we are moving 20 in the market.
And how do we know what is the nominal of our Forex operation?
For that we will have to review some basic concepts of Forex trading. But in summary, with a lot the nominal of the operation is 100,000 currency units of the base currency, with a minilot the nominal of the operation is 10,000 currency units of the base currency and with a microlot the nominal of the operation is 1,000 currency units of the base currency.
Advantages and disadvantages of leverage
The winger has good things and bad things, like everything in this life. As a main advantage we can say that leverage gives us the opportunity to grow our account more quickly, as long as we manage it well. The main drawback of leverage is the risk that supposes to have high leverage without good management.
So what if we get too close?
Because we will be risking a lot for each transaction (assuming that the distance to the stop is the same and we only vary our leverage) and in a few transactions we will decapitalize our account. Asymmetric leverage comes into play here, we could define asymmetric leverage as the progressive reduction of the capacity to recover losses, with an example we will understand it better.
Imagine that we have a 100 account and in a transaction we risked 1% of the account and lost it, that is, we lost 1.
Now our account is 99 and to bring it back to 100 we have to earn 1.01% in the next operation, this is what 1 out of 99 represents, practically the same as what we lost.
But if instead of losing 1 we lose 10, 10% of the account, we will have to recover 10 out of 90, which means 11.11% of our current capital.
And if we lose 25% of our account, we will have to earn 33.33% to get back to 100.
As we can see, to recover a loss of 50% of our account we have to win 100%. The point of no return, that is, the hole from which it is very complicated to recover the loss is between 20% and 25%
Now let’s see how closely this point of no return is according to what we risk. In the following table we compare how many consecutive losses are needed to overcome the point of no return (we caught 25%) if we risk 1%, 2%, 3%, 4%, 5% and 10% per operation.
As we can see in the table above, if we risk 1% per operation, we will need to lose 29 consecutive times to reach the point of no return, with a risk of 2% per operation we will need a burst of 15 consecutive losses to overcome this point , with a 3% risk we will need a total of 10 consecutive losses to exceed this point and with a 10% risk per transaction we will exceed this point for the third consecutive loss.
Obviously, this is an approximation to see what would happen if we move with leverage, because in real operations monetary management would also come into play.
What is the optimal leverage?
With respect to this theme there are many theories and each one has their own opinion regarding it, for colored tastes. That is, that there is no holy grial, there is not a single truth. Looking for information on this topic on the site I found this post that I wrote forero Imarlo a few years ago (which I recommend reading) in which he comments on Lars Kestner’s formula, which gives an approximation of the optimal leverage by dividing the average of the turns of an investment method or a trading system between their variance, such that if the average increases, the optimal level of leverage will increase and if the volatility (risk measure) increases, the optimal level of leverage will decrease.
On the website, in books or in courses / seminars, we can find other approaches to calculate the optimal leverage, others recommend not to exceed a 1:10 leverage, others a 1:20 leverage. But as I said before, there is no optimum level of leverage, the best level of leveraging will be that with which we are comfortable and that above all does not cause us to decapitalize our account in the blink of an eye, and more in the Forex market, that there are brokers that allow a leverage of up to 1: 500.
Conclusions on leverage
In short, leverage can help you get greater benefits from trading, but you have to understand very well how it works and have it controlled at all times, because as we explained earlier, if we do not have control over it, it is very easy to get to the point of no back from the account. That is why it is important to practice with a demo account.