How Leverage Increases Forex Trading Profits & Loses?
If you have a 1,000 dollar account with leverage 100:1 you as a trader can buy a maximum of 1 lot which is equivalent to $100,000 dollars contract(1 Standard lot).
Let us calculate profits & losses based on three examples of used leverage, based on $1,000 trading account:
- 1 lot(100:1)
- 0.5 lots(50:1)
- 0.2 lots(20:1)
NB: This is the Leverage used not the Maximum leverage, If a broker gives you 100:1 leverage, but you only trade 0.1 lot the used leverage you are using is 10:1, But if you trade 1 contract then the you'll use is 100:1 which is equal to Maximum(100:1).
So the example referred in this below is talking of the leverage used based on the volume of the trade which you have opened.
Example 1: (100:1 Leverage or 1 Lot)
For 1 lot 1 pip equals $10 dollars
If you make a profit of 100 pips the calculation of profit in dollars is:
1 lot
1 pip = $10 dollars
100 pips = 100 * 10 = $1000 dollars
Total= balance + profit
= 1000+ 1000
= $2,000 you have just doubled your account balance
If you accrue a loss of 100 pips the loss in dollars is
1 lot
1 pip = $10 dollars
100 pips = 100 * 10 = $1000
Total= trading account balance - loss
Total= 1000 - 1000
Total = $ 0 you have just lost your trading account balance
Example 2 :(50:1 Leverage or 0.5 Lots)
For 0.5 lots 1 pip equals $5
If you earn a profit of 100 pips the profit in dollars is
0.5 lots
1 pip = $5
100 pips = 100 * 5 = $500 dollars
Total= balance + profit
= 1000+ 500
= $1,500 dollars
If you accrue a loss of 100 pips the loss in dollars is
0.5 lots
1 pip = $5 dollars
100 pips = 100 * 5 = $500
Total= trading account balance - loss
Total= 1000 - 500
Total= $500 you have just lost half of your trading account balance
Example 3: (Leverage 20:1 or 0.2 Lots)
For 0.2 lots 1 pip equals $2
If you earn a profit of 100 pips the profit in dollars is
0.2 lots
1 pip = $2
100 pips = 100 * 2 = $200 dollars
Total=balance + profit
= 1000+ 200
= $1,200 dollars
If you accrue a loss of 100 pips the loss in dollars is
0.2 lots
1 pip = $2 dollars
100 pips = 100 * 5 = $200
Total= account balance - loss
Total= 1000 - 200
Total= $800 you have just lost 0.2 of your trading account balance
From the above example you can see that the more leverage you use the greater the profits or losses & less you use the lesser the profit or loss.
It's therefore better to use less leverage so as to cap the risks involved. The higher the leverage ratio used the greater the risks. This is one of the leverage guide-lines not to trade with more than 5:1 leverage option.
In trading leverage guide-lines: It is always recommended to stay below 10:1 leverage ratio which's also still high, most professional money managers use 2:1 leverage meaning they trade only 2 lots for every $100,000 in their account.
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