Large leverage vs. small leverage
Everyone Trader sooner or later faces the notion of Leverage, margin and collateral. And, having penetrated into the essence of the question, traders are divided into two camps. The first one associates high leverage with inevitable loss of deposit. The others consider this tool useful, moreover, associating it with the possibility of diversification due to small margin and good stock of free funds. There are other pluses as well as minuses. Let's try to understand?
What is leverage?
To begin with, let's answer the question: what is leverage? Leverage - is a lever that Increases the trader's giving back on a pledge to open and maintain a position. In this case the broker's role is to provide the trader with the necessary amount of money on margin trading conditions. Thus, The main principle of margin trading is to provide leverage.
For example, 1:100 leverage tells you that you will need a hundred times less to buy or sell 10,000 units of the base currency - only 100 points of the base currency. This amount is called margin (from the English margin - collateral) and in the base currency is calculated by the formula shown in Fig. 1.
How does leverage work?
The leverage can be from 1:1 to 1:500 (and even more). Let's do the math. Let's compare 2 leverages: 1:500 and 1:100 and find out how much money we will lose if we use them to trade EUR/USD of 1 lot on a deposit of 10 000$, subject to the occurrence of a stop-out at the margin level of 10%. For example, with a leverage of 1:500, on a position of 10,000 units of the base currency, we would need a margin of 20 points of the base currency (10,000 / 500).
In the case of 1:500 leverage in pledge leaves 266.42$. 10 000$ - 266.42$ = 9 733.58$ remains to trade, 9 733.58$ we will lose at a drawdown of 973 points (a 4-digit quote) at a point value of 10$. At this point, the margin level will be 100%, that is, we will be left with only our margin of 266.42$, and the stop-out occurs when 10% (26.6$) remains of it. So that leaves us with 266$ - 26$ = 240$, which means there will only be 24 points before the stop out. In fact, the stop-out will come at a drawdown of 973 + 24 = 997 pips, and after the stop-out we will have 26$ on the trading account.
In the case of 1:100 leverage in pledge leaves 1 332,10$. Total 10 000$ - 1 332,10$ = 8667.9$ remains to trade, 8667.9$ we will lose at a drawdown of 866 points (4-digit quotation) at a point value of 10$. At that point, the margin level will be 100%, which means we will be left with only our margin of 1,332.10$. Stop-out occurs when remaining 10% of the deposit (133.2$), so we have 1,332.10$ -133.2$ = 1198.9$. That is, there will be only 119 points before the stop-out; in fact, the stop-out will occur at a drawdown of 866 + 119 = 985 points. After the stop-out we will have 133.2$ left on the trading account.
As we see, with a leverage of 1:100 and 1:500 before the stop-out the difference is 997 - 985 = 12 pips. That is, if you sometimes exit with 1 lot volume on one trading instrument with 1 000$ - 3 000$ deposit - you will forever remain in the list of losers, because it clear risk violationAnd decreasing your leverage from 1:500 to even 1:50 will not help you.
The meaning of margin is that it guarantees the competence of the trader to open a position of a particular volume. As long as the position remains open, the broker will hold a margin (as a pledge), not allowing to open new positions with this amount. The question arises: what to do if we want to open several trades at the same time? Then we need either a larger amount of funds in our trading account, or a larger leverage.
It does not matter what market you plan to use leverage on, the main thing is to understand - what it affects. And, as many believe - The use of high leverage promises great losses. In this case, we do not recommend increasing the volume and bring the account to a drawdown of more than 10-20% from the equity (means) deposit, not to mention the stop-out.
Why do I need high leverage?
1. You have there are always more funds availablewhich allows you to connect a new trading system on your current account.
2. With different trading systems, we have options to work both with different constant and with different varying volumes Depending on the type of signal or presence/absence of drawdown. Therefore, there may be a situation when we need 1 lot of open positions during 99% of traded time, but during 1% of traded time the actual volume will be 20 lots in order to keep the growing equity.
3. In portfolio management maximum leverage is always relevantAs the total equity is always growing when the portfolio is formed correctly, reducing leverage leads to a decrease in profitability due to the inability to set the maximum volumes at the time of the beginning of the withdrawal from a drawdown.
The more leverage, the more available funds. It is high leverage that will allow you to add more trading instruments to your investment portfolio, and each new instrument or trading system you add will reduce the risks of the entire portfolio. After all, while an order for one instrument is in a drawdown, another order comes out in profit. Of course, this requires the ability to competently diversify risks on the portfolio. Thus, the greater the leverage, the better the diversification works and there is an opportunity to increase overall profitability.
From an institutional point of view, high levels of leverage exist only in the market . In this regard, participants in other financial markets sometimes The market is not yet ready to accept them, arguing that with the beginning of market regulation, large amounts of leverage will disappear from the arsenal of trading conditions - brokers. At the same time, for example, the Cyprus jurisdiction allows the use of the maximum leverage of 1:500. And, as we found out in the calculations above, with low leverage you can trade too, the only thing you will be limited in is your available funds. So make the most of today's opportunities to trade to the fullest!
Happy trading!
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