What is the Perfect Leverage?

Leverage is all around us, but it is poorly understood. In FX, for example, you can achieve leverage as high as 400:1 in some jurisdictions 🌍, and even the most regulated places in the world, like Hong Kong 🇭🇰, Japan 🇯🇵, the EU 🇪🇺, and the US 🇺🇸, offer margin at 25:1 and 50:1.

Most retail traders, however, confuse the concept of margin and leverage. Margin is the maximum amount of credit that your broker will extend to you. So, at 100:1 margin, you can actually trade a 1M EURUSD position with as little as $1,000 in your account 💵.

So, 100:1 margin is the possibility of trading a million EURUSD position with very little actual cash. But no one is forcing you to do that. No one is putting a gun to your head 🔫. You can, for example, just trade a 1,000 EURUSD position employing no leverage at all.

Margin is what the broker offers you. Leverage is what you choose to take.

What’s the right amount of leverage?

There is no right answer. Leverage is a very personal thing and it can vary not just by the trader but by trading instrument and strategy ⚖️.

There is, however, an answer to the question of what is the wrong amount of leverage, and that answer is anything above 10:1 🚫. That may seem extremely modest, especially for those of you who trade FX, but anything above that number will wipe out your account eventually and often much faster than you think ⏳.

Why? Because when most retail traders think about leverage, they are thinking in terms of an opening bet 🎲. Suppose you have a $10,000 account and you decide to trade 10:1. You open up a 100K EURUSD trade. A few hours later, you may see a setup in AUDJPY, then in EURNZD, and then in EURJPY, and so on and so forth. Soon, you have five trades and 500K of open positions subject to market risk and are effectively trading at 50:1 leverage. If all five trades get stopped out for 1% each, you just lost 50% of your account 💔. It’s the easiest money your broker ever makes. They don’t have to manipulate prices; you are perfectly capable of bankrupting yourself 💸.

That’s why you always need a buffer. A good rule of thumb is to have 5X as much money in your account as you need to have for one single 10:1 trade multiplied by the max stop loss you would take on a trade 📉.

So, if you are attaching 50 basis point stops to your trades (0.5%) on 10:1 leverage, then multiply it all by the max number of trades you will have open at one time. Let's say you are trading a 10,000-unit position on $1,000 of capital and a 50bp stop. This means you are risking $50 per trade. If you intend to open up to five trades at one time, then just multiply 5x50x10 (max number of trades x average stop dollar value x max leverage factor), and your answer will be $2,500. That will give you both a financial and psychological cushion to trade without worry 😌.