Risks of Using “High” Financial Leverage (at Max)
Despite the fact that there have been loads of expert articles about leverage effect where we can read how such leverage works, what does it bring and what are the risks, there are still a number of traders in the market that ignore such risks completely.
Even more, there could be a spill-over effect of these traders when the new, starting traders could emulate their way of using it.
We could write here an entire book about how to work with leverage and how to set it up. However, when it comes to the right variables for leverage, there is not universal advice, unfortunately. Therefore, it depends only on the skill of each trader how he can adjust the leverage to his trading account and trading strategy.
At the same time, we will familiarize with the difference between a technical and a real leverage effect and with the hazards that the use of leverage at max may bring.
Technical versus real leverage effect
Technical leverage effect is the maximum leverage that is provided to traders by their broker. It’s important to emphasize that, in general, the highest technical leverage is provided by brokers only for a certain instrument (in particular forex instruments), therefore in case of other instruments, the leverage may differ markedly (it’s often lower).
Real leverage effect – differs from the technical one in the fact that this is the leverage used by the trader for real.
We will analyse this issue more deeply by using the table below. Resulting values in the table are calculated by using an example of a trading account with $1,000.
Now it should be clear from the table above that even if the broker (e.g. for forex instruments) offers a technical leverage of 1:400, but the trader opens 1 forex (e.g.: EURUSD) trading position with a size of two micro lots ($2,000), then he uses in fact, with regard to the size of a trading account ($1,000), a leverage of only 1:2. Therefore, a simple equation applies here – the higher the volume the trader trades at the moment, the higher the real use of leverage is (real financial leverage).
Financial leverage used at max and its hazards
Trading, where the leverage higher than 1:10 (or at maximum) is used, represents a real hazard from a long-term perspective. Therefore, let’s demonstrate in our second table how many points are we on such trading account ($1,000) under using fulling leverage (e.g. for EURUSD) from its running (coming to zero).
Not only such use of a relatively “high” leverage increases the potential of ruining your trading account, but there’s an additional factor that should not be disparaged.
This additional factor is the costs related to keeping such a position overnight (swap). If the financial leverage is used in full, e.g. 1:400, and we calculate with 10 points/roll ($10/lot) for keeping a fully leveraged trading position at EUR/USD, then we’ll realize by using a simple math that in such case the trader is going to lose 4% of his trading account, regardless of its size. It will always be 4% in this case, regardless if it’s a trading account with $1,000 or $10,000.
As stated above, trading with leverage and setting its size is a significantly hard task while such setting of an optimal size required real sentiment for trading. When setting and using the leverage, it's always necessary to have everything calculated in advance and, in short, you should know what are you doing in fact and what effect does it have.
If you start to use the leverage properly and with sufficient margin, you’re on the right path to achieve potentially profitable trading – despite the risks and potential hazards stated above, such leverage provides traders an undeniable advantage to achieve very interesting results with relatively low capital.
If you are interested in trying out trading and to become familiarized with leverage, don’t hesitate to try it all out on our demo account completely for free and free of any risk and open the account on our website here: www.purple-trading.com
About the Author
Team Purple Trading
Purple Trading is a true and 100% fair ECN / STP forex broker providing direct access to the real market. High speed orders execution, no trade-offs, no limits for any type of trading, the most advanced trading technologies. Explore more about Purple Trading at www.purple-trading.com .
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 74,8% of retail investors lose their capital when trading CFDs with this provider. This value was determined within the period from 01 January 2018 to 31 December 2018. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
Trading forex exchange with margin carries a high level of risk and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to trade foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. You could lose part or all of your initial investment and therefore you should not invest money that you cannot afford to lose. Seek independent advice if you have any doubts.
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