Understanding Leverage, Margin and Risk In Forex Trading
In this video:
00:27 How leverage, margin and risk affect Forex traders
03:48 Different scenarios regarding pips
05:32 A really good month of October with +8.5% return
The Difference Between Leverage, Margin and Risk in Forex Trading
As Forex traders you need to understand the difference between leverage, margin and risk. So let’s talk about that right now.
Hi Forex traders, it’s Andrew Mitchem here, The Forex Trading Coach and in today’s video and podcast I’m going to be answering a question that I’ve had, emailed through to me from Tom and he said, “Hey Andrew can you explain about leverage and margin and risk and how it affects us as Forex traders.
And so if you have any questions that you would like me to answer along those type of lines, any topics that you have please do send me an email and I’ll do my best to answer those for you on future videos and podcasts.
So let’s talk about leverage to start with.
Leverage: Leverage really is how much of your broker’s money you can use and brokers can vary between 10-1, 50-1, 100-1, right up to about 400-1 leverage. Personally I’ve always used 100-1.
Now that if you’re in the U.S. of course you do have some restrictions but really leverage isn’t so much an issue if you have sensible low risk control trading approach. If you have ridiculously high risk then leverage does become an issue and having a low leverage such as what you can have in the U.S. does become more of an issue.
But really the way that I trade which is as a business and to treat trading seriously low risk; 100-1 leverage is absolutely ample.
Margin: The second thing – margin. Really what the margin is how much money is available in your account. So money that is not currently tied up in any open trades, how much do you left there to trade with. You don’t ever need to get into a situation where you have a margin call and that’s when you don’t have enough money left in your account to cover your open positions and your broker will close all your positions and generally that’s end of your account.
Now you really should never ever get to that situation. Again if you do, it means that you’re just gambling with your trading.
Risk: That’s really one thing that you can control yourself and it is s personal type of thing but it is really important to understand the risk properly. Now with the way that I personally trade and the way that I teach people to trade is I risk no more than half of 1% (0.5%) of my account on any one trade. Now that doesn’t matter what the time frame of the chart is, what day of the week it is, what currency pair is, whether will be a buying or selling, pending order or market order; it doesn’t matter. 0.5% is the maximum that I would trade on any one trade.
Sometimes it’s a quarter percent but if 1% is what you are comfortable with then use 1% but personally I think 0.5% is plenty. What it does is it helps you to take trades on any time frame charts and it also helps to keep your emotions under control within your trading because you know the very worse you can do is lose half of 1%. So it means that if trades happen to stay on why you’ve got to work while you’re sleeping or while you’re away from your computer that doesn’t really matter because you have your stop loss in place and you know that X numbers of Dollars or Pounds or Yen or whatever it is that’s in your account is the most that you can lose if that trade gets stopped out.
Now I’ve just came off a Skype call with a guy in Perth and I’ve just explained risk to him as well because to start with we were talking about pips and I was explaining why to me pips are not really that important.
Now I’ll give you the same scenario as I gave him a few minutes ago.
Let’s say you took four trades on the 15-minute charts for instance and all four were profitable and they all made let’s say 15 pips each. That’s fantastic, you know, you’ve just made yourself 60 pips.
Let’s say you also took another trade, your 5th trade was taken on the 4-hour charts or the daily charts; it doesn’t really matter but a longer time frame chart generally has a bigger stop loss.
Let’s say that, that trade had a 70 pips stop loss and it got stopped out so here you are on one hand with four trades all profitable, they made really good money and you have one trade that got stopped out and you lost on that. So you’ve made 60 pips and lost 70. You’re -10 pips so if you start trading with X amount of dollars per pip and you trade that way which is the traditional way that most people trade, you’re now minus 10 pips (-10) so how many dollars that equates to.
Whereas if you had controlled risk on each one of those trades, let’s say they will have the same risk to reward margin or return. Let’s say for the sake of ease of numbers they were all 2 to 1 trade. You now got 4 profitable trades making 2 to1 and you’ve got 1 losing trade loosing 1 part. So now you’re in huge profit because you’ve got away from the mentality of pips and you’re looking at return per trade and controlled risk.
So that’s a really important aspect of risk that we try to understand.
The other thing quickly to mention is that, personally I had a really good month and a lot of my clients had a really good month of October and with my personal account I’m up 8.5% for the month so very happy with that return with again low risk.
Lastly, don’t forget that the U.S. clocks change this weekend and so the daily charts still remain at 5PM Eastern Standard Time (EST) but for those of us not in the U.S. it means that your daily charts and the 4-hourly charts, etc., everything will now open and close so the new day opens 1-hour later than what it has done recently. So just bear that in mind if you’re trading on daily charts, the start of the week is 1-hour delayed for those of us outside of the U.S.
So hope you’ve got some really good benefit and really good information from this webinar. My name is Andrew Mitchem from, The Forex Trading Coach.