How did you get this far without knowing where to set your leverage?
You like money, right? Hate losing it? Yeah, me too. Listen up.
You can always just listen to the podcast below, or continue reading on…
This week’s question is one I’m hearing for the first time, and it’s a bit disturbing it’s taken this long to be honest.
“What should my leverage be when trading Forex. I do not want to lose all of my money”
Julien — Avignon, France
So this might not be the most exciting topic we’ve ever had on the podcast, but I pity the fool who doesn’t get this right.
Have you ever had anyone explain leverage and margin to you before? I haven’t. I had to look it up online, in places that over-complicate everything and provide too much useless information, and I still came out confused.
So let me put it to you this way, and then you’ll always know.
The Way I Explain It
Here is all you need to know when it comes to Forex leverage:
Understand what Forex margin is, and you will understand leverage.
Ever wonder why you can’t start a real money account with $500 and start trading the GBP/USD at $20 a pip?
Margin.
You only get so much margin to use. When you make a trade, you use part of it up. When you close a trade, you get it back.
How much margin you use per trade depends on how big the trade is. You can be a dumbass and use up all of your allowed margin in one trade if you wanted to. But then you won’t be allowed to make another trade until that one is closed.
The higher you set your leverage, the more margin you get to use. But if you’re trading wisely, you don’t need your leverage to be that high.
500:1 Leverage? Fuck Yeah!!
If you get excited at the thought of 500:1 leverage, you’re dead before you even know it.
A lot of brokers will allow you to do this. They would love nothing more than to take the other side of your trade, which is what many brokers do, and take all of your deposit for themselves.
They know you’re dead money. For them, people like you are the lowest hanging fruit out there.
Why is it that mostly poor people play the lottery? Is it because they’re poor and they don’t want to be anymore?
Yes, but it’s mostly because poor people have a terrible understanding of money, and make choices to play games where the odds are stacked highly against them.
“You go to hell VP, we love playing the lottery!”
If you want a broker who allows leverage like this (and there are 240 google searches a month for “high leverage Forex brokers”), you and these lottery players have one thing in common — you’re destined to be poor the rest of your lives unless you figure it out, fast.
Hooray For Over-Reaching Government!!
Government doesn’t need an excuse to limit what you can and cannot do, but if you give them one, they’re gonna milk the crap out of it.
“We don’t know you, but we have your best interests in mind”
So on the heels of the financial crises of years back, the US government and the EU both took measures to limit your leverage options in Forex severely.
The good news is it doesn’t matter much to you (unless you are an American who wants to trade spot gold, then you’re screwed). But let’s touch on it real quick.
The Dodd-Frank Act was passed in 2010, limiting Americans to 50:1 leverage in Forex, and 1:1 in metals trading. The government cited a number of hedge funds and high-risk fund managers using ridiculous margins on gold to justify this.
In 2018, the European Securities and Markets Authority (ESMA) reduced leverage on major Forex pairs to 30:1, and leverage on minor Forex pairs and also gold to 20:1.
Traders outside of the US and the European Union are not affected by these rulings to my knowledge.
So Here Is What You Do
As always, I give you a real, straight-forward game plan you can go implement right now.
But I will give you two options. Peeps in the EU, you will sadly now only be able to use Option 1.
Option 1
This is the one I use.
Set your leverage to 20:1, and be done with it.
You don’t need more than this if you are trading with a smart risk profile. We will go over risk soon, but if you have your leverage set at 20:1, and you’re constantly running out of margin, you are risking too much per trade, or you are over-trading.
This will be a good barometer for you to see if you’re doing it wrong or not.
If I recall correctly, the most trades I’ve ever had open at one time was six, and even then, I could have made a couple more and been just fine with my margin.
It should be plenty for you, and then you’ll never have to worry about it ever again.
Option 2
Maybe you’re not comfortable putting all of your trading capital into a brokerage firm you don’t 100% trust. Even the biggest ones can crash after all.
I call this the “half-in, half-out” method.
I always use $50,000 as my arbitrary number. If you have $50,000 of trading capital to use, put $25,000 into your brokerage account, and leave $25,000 behind.
You are still trading with $50,000 technically, but you are not risking having it all in some broker’s lap.
Problem is, the broker is only going to see $25,000, and only give you enough margin for a $25,000 account. You will not be able to make the trades you want to make at this level.
What do you do?
You double your leverage of course. Take it to 40:1, and you’ll be able to make the same types of trades as you would at 20:1 on a $50,000 account.
Conclusion
This isn’t something you need to spend a lot of time on. But understanding what it is, and setting your account at a leverage that makes sense is a required must in Forex trading.
And the half-in half-out strategy, simple as it appears, is something most traders never think of. Because I trade for a firm it doesn’t apply to me as much, but if 100% of my income came from trading my own money, you bet your ass I’d cover my own.
Money Management is still the most important concept in Forex trading. It’s not the most fun, but if we can get yours as tight as possible, the rest magically becomes easier and easier.
You’ll see.
— VP