Leverage and How to Be In Control
Leverage is basically a facility which is offered by your broker to trade a larger amount despite of having a smaller account balance. Say your broker is giving you a leverage of 500:1 you can then trade worth 500 times in your account. Although, you can, being a smart trader you should never do so.
As mentioned in the Risk Reward Management post, you should always risk a certain percentage of your trading account; this is to control your leverage that you take on your account. Using this method usually gives you an edge where your trade is calculated and you are aware of the risks to your trade giving you the feeling of being in control of your trade.
Before discussing the drawbacks of high leverage let us discuss margins and margin calls. Margin is the amount which is being traded in your position size on all of your trades, its the amount you need in your account to keep your current trade active. In other words your equity can not in any case fall below that or you’re in deep trouble! The remaining amount available which can be used for opening other positions is called free margin, the free margin is the trad-able amount left in your account as well so every trade you open, your free margin drops and you have less trad-able cash in your account. So make sure you don’t max your account out just by opening positions without any idea about what margins they’ll take. Your broker can guide you to the required amounts to opening a certain lot size on all currency pairs.
Now what the heck is a margin call?? These words are the two most dangerous words for any trader out there because it could mean that he or she is at the verge of losing all the money in their Forex trading account or their entire savings maybe. You can understand this term in a simpler way by saying that margin call is when your account has reached a minimum level where you can’t even hold the positions you have open, so your broker will cut them off for you.
Suppose you go on opening trades with big positions thinking that you can use leverage facility and trade more money than what you have in your account and earn some quick money. It can happen for sure but what if the market goes against you? The odds do no not turn out in your favor? And your account starts showing you big losses? And then the market keeps on going against you and your equity equals your margin? Now here your broker will start cutting off your trades leaving you with a very small or even possibly an empty account, I know even the thought is scary! We don’t want that to happen to you, so trade with your risks in mind, it is the best favor you could do for yourself.
This was just a scenario which can occur with any new trader if he or she is unaware and doesn’t have proper knowledge with respect to controlling leverage and the postion sizes they use. So always risk as much as you can bear losing and make sure that amount is not a high percentage of your account, and you are not at any cost getting a margin call. Leverage is a benefit so use it for your advantage. IF you do want to leverage a little extra than your normal, I’d suggest you do it in a trade which you are very comfortable, still we would suggest not to make unnecessary over leveraging on your account, because you never know. In the end it depends on you because you and you alone are in the trading seat and responsible for your actions.
Have you ever been close to a margin call or faced one? Please share the mistakes you made so other traders can learn from them and avoid them.
If you have any nice techniques for controlling leverage, any methods to manage your risks and even calculate your position sizes, please feel free to discuss them in the comments so other’s can also benefit from them. It’ll surely guide the newbie trader on his journey to being a smart trader and who know’s maybe give me a few ideas too? 🙂