Leverage Amplifies Gains and Losses — and Expectations

Leverage refers to the multiple applied to your available margin, which translates to the maximum size of your position in the market. Leverage is usually expressed as a multiplier (eg 10x or 20x) or a ratio (eg 10:1 or 20:1). If the leverage ratio is 10 times/10:1 ratio, for example, and you have $1,000 of available margin, you can hold a maximum position of $10,000.
Online forex trading companies usually offer higher leverage ratios than you might be accustomed to from trading stocks on margin. Leverage ratios among currency brokers are usually in the range of 100:1 for standard-size accounts (100,000 trading lot size) and 200:1 for mini-accounts (10000 lot size).
Recent regulatory changes around the world have reduced the maximum leverage ratios to lower levels, such as 20:1 in Hong Kong or 50:1 in the US, which is more than enough for individual traders.
Be wary of forex brokers that offer high leverage. Some offers reach up to 400x leverage, or 400:1. We strongly discourage you to use that much leverage. Additionally, regulatory restrictions on leverage have seen some traders head into the shopping circle in search of the highest leverage available, but end up in fraudulent places that may carry additional risks.
Leverage is a great trading tool, as it allows traders with less capital to participate in markets that they would not otherwise be able to trade. But leverage is still just a tool. As with any other tool (think a saw here), if you learn how to use it properly, you’ll be able to get the job done faster and easier. But if you don’t learn how to work and respect it, you’re asking for trouble.
Most people only see the upside benefits of leverage – the higher the profitable trading position, the higher the profit, right? Yes, leverage will magnify your gains, but it will also magnify your losses – the higher the position on a losing trade, the greater the loss you will face. You need to have a good respect for the downside risks of trading, otherwise it won’t last long.
Take an example of a $100,000/lot account with an initial margin of $10,000 deposited with a leverage ratio of 50:1. This margin balance translates to a maximum position size of $500,000, or five contracts. If you were to take a USD/JPY position at 90.00 using the maximum available position size, then each pip change in USD/JPY equals $55.55 ([$500,000 x 0.01 pips] / 90.00 = $55.55).

But the USD/JPY pair is regularly subject to price fluctuations of 50 to 100 pips in one day (or more). If you are put in the wrong direction, you could lose around $2,778 to $5,555 in the course of a normal trading day. This represents about 28 percent to 55 percent of your trading capital in just one trade!
The key here is to avoid getting caught up in leverage. Just because you are able to get 100:1 leverage doesn’t mean you have to use it all. Trading a larger position may sound exciting, but no one ever said that prudent and risk-aware trading was supposed to be exciting. Use leverage as a tool to facilitate your trading strategies, not as a means to boost your ego.