There are many misconceptions/myths when it comes to leverage and their relationship to your profitability or ruin.
Many gurus and experts always advise against using high leverage, citing it as a sure thing to failure. What they fail to explain is that it depends on the kind of forex trading strategy you are using, the size of the stop loss, the size of each position and the total size of all your trading positions.
In view of that, I think it would be useful to differentiate them as ‘position leverage’ and ‘portfolio leverage’.
Assume 2 traders, A and B, has one position each (Long 100,000 units of USD/JPY) and a $50,000 USD funded account with 50 times leverage given by the broker.
The value of the position is obviously $100,000. At 50 times leverage, Trader A will need to post a margin of $2,000 (100,000 / 50 = 2,000).
That would mean they have a 2 times leverage ratio, as they now have a $100,000 open position on $50,000 in capital.
Trader A trades a long term trend following strategy and has his stop loss set at 300 pips and gunning for a 1000 pips target/TP point.
Trader B has a similar position in USD/JPY, but he is a day trader and has set a 20 pips stop loss while trying to capture a 50 pips profit.
Trader A will be risking $3,000 or a whopping 6% of his capital on a single trade, while Trader B will be risking $200 or 0.4% of his capital. Although they employ the same level of leverage, it does not have any bearing on how much risk they are taking.
Trader C on the other hand, has 3 open positions. They are Long 100,000 EUR/USD, Long 133,680 USD/JPY and Short 100,000 EUR/JPY respectively.
Assuming EUR/USD is trading at 1.3368, he will theoretically have no risk exposure. But he would still be required to provide about $8,000 in margin ($2,674 for each).
I have no idea why he would want to do this.
Some JPYs are ‘missing’ due to spread and rounding errors in the calculations.
It would be prudent to not risk more than 2% of your account balance on any single trade or 5% on any one currency.
So using the above example of $50,000 in capital, you should only risk a maximum of $1,000 on each trade.
For trader A using a 300 pip stop, his trade size should only be 33,000 units or about 3 mini lots. As for trader B, using a 20 pip stop, his trade size can reach 500,000 units, or 5 standard lots.
Regarding not risking more than 5% on any one currency, imagine you are long EUR/USD, GBP/USD and short USD/CHF at the same time. You are actually long European currencies and shorting USD in all 3 positions.