Leverage Your Money: Higher Profits, Higher Risks

Written by: Dave Green • Tuesday, July 31, 2012 • 2 min read

• Last updated: Tuesday, July 31, 2012

The level of risk, or in other words- leverage, is one of the most critical points for Forex traders. The debates on which is the most recommended leverage and what is the best way to use it are infinite. First, let me say that the technical explanation for leverage is “A lawn given to investors by the broker who runs their trading accounts” (taken from Investopedia).

The most important thing to remember about leverage is that it is a double-edged sword: The higher it gets, the higher your chances for big profits, but it also goes the other way, and you risk losing your money faster, and more painfully.

Many traders ask for my opinion on leverage. I will explain my opinion by giving two examples which demonstrate right leverage usage:

Let's take Jack. Jack is a day trader. Jack usually opens 4-6 trades a day, hoping to collect 20-50 pips earnings per each trade. According to this description, we can assume that Jack is a low-medium risk taking trader, who sets his Stop Loss levels in a 3:2 ratio to his Take Profit levels, meaning, 40-60 pips distance from his entry points.

The correct leverage for this type of trader would be times 25 to 50 max, because Jack is not a big shot long term investor who seek to make enormous gains of hundreds or even thousands of pips per single trade which can last up to few months. He is looking to collect his gains at the end of the day, and to sum up his conditions at the end of the trading week. Due to these circumstances, he doesn’t risk too much. He trades with a relatively small part of his total account capital, and keeps high market sensitivity. That way he could make from a few hundred, to a couple of thousand Euros per week.

Now, meet Jones, a long term investor, who trades long term positions that can last up to half a year. Jones has big bucks in his trading account, and he is more of an investor than a trader. He hedges his money, and doesn’t want to lose all of his money in case the market suddenly goes against him. Jones usually trades two or three trades simultaneously, with intensions of making at least a few hundred pips per single trade.

He is not that sensitive about daily happenings or daily financial events which take place in the markets, as he seeks the longer term trends, the kind that the market waits for. For example, Jones is the type of trader who sensed the collapse of the Euro a couple of months ago, opened a long term position, and is still waiting for the right exit point. For traders of Jones's kind, I would not suggest leverage higher than times 10.

So, as you can understand, different leverages suits different types of trades. I hope I helped, and in any case, I never trade with leverage higher than times 50.

What is your preferred leverage? Share it with us