What is the spread?
17 August, 2021
What is Forex? And how it works?
17 August, 2021

How does leverage impact your trading?

Leverage has a multiplier effect that allows you to place operations as if you had a capital greater than the real capital that you have deposited in a trading account, this effect allows you to obtain large profits on winning traders, but it can also generate large losses on losing trades.

How does leverage raise our profits and / or losses?

Let’s imagine that you are a trader who operates with a Forex broker and they offer you a leverage of 1:50. That is, for every dollar you place in your account you can trade up to US$ 50.

You have US$ 5,000 in your trading account, which means that you can carry out operations up to a maximum of US$ 250,000 (US$ 5,000 x 50).

Example 1 – We sell EUR/USD or, we go short in Euro and long in Dollar:

We will sell 100,000 units of EURO that is 1 lot.

When we start the Trade we have a ExRate of 1 Euro = 1.3600 USD. In EUR/USD it would be 1.36. Since we are short on the Euro we are looking for the value of the Euro to fall against the dollar.

Leverage: Your leverage in this trade is calculated as follows (136,000 USD / 5,000 USD = 27.2). That is, your leverage for this trade is 1:27.

Value of the PIP: In the case of the EUR / USD the pip is represented by the variation in the 4th decimal place, that is, 0.0001 or 0.01% of the amount traded in the base currency represented in the cross currency. The calculation for the value of the PIP will be the following:

We are trading 100,000 units of Euro, the pip is measured at the fourth decimal 0.0001 and the ExRate of the EUR/USD is 1.36.

(0.0001 / 1.36) * 100,000 = 7.35 Euros x pip. It must be converted to USD: 7.35 * 1.36 = 10 USD x pip.

Stop Loss: We are going to place a 50 pip SL, so our maximum possible loss would be US$ 500 (50pips x $ 10xpip).

Profits or Losses: Let’s imagine that the TC of the Euro falls to 1.3400 in a couple of days and you decide to close your position at that level.

Your profit would be the following: (1.3600 – 1.3400) = 0.0200, in other words, there is a difference of 200 pips in your favor. 200 pips x 10 USD x pip = 2,000 USD.

Understanding the Buying and Selling of Currency Pairs

What you did in this operation was to sell 100,000 units of Euro and you bought 136,000 units of USD. At the time of closing your operation it is as if you had bought back your 100,000 units of Euro but at a lower rate of 1.34. That way you would have paid 134,000 USD for your 100,000 units of Euro and the difference of USD$ 2,000 is your profit.

Having used leverage allowed you to generate a 40% return on your initial investment of US $ 5,000.

If you had not had leverage, the operation would have been like this:

If you have 5,000 USD in your account and want to go short on the EUR/USD. You could only go short with 3,676.47 Euros (USD$ 5,000 / 1.3600). At this trading volume, how much is the pip worth? Doing the calculation, in this operation the value of the pip would be only 0.36764 USD x pip.

If you had made 200 pips on this trade, your total profit would have been US$ 73.528.

What does this mean? That your 1:50 leverage allowed you to earn up to 27 times more than if you had not used leverage.

Example 2 – We sell USD/JPY or, we go short in Dollar and long in Yen:

We will sell 200,000 units of Dollar that is, 2 lots.

When we have started the trade, the TC of the dollar against the yen is 85.23 (USD / JPY = 85.23).

In our previous example we made US$ 2,000 so we now have in our account the sum of US$ 7,000.

Leverage: Your leverage in this trade is calculated as follows (200,000 USD / 7,000 USD = 28.57). That is, your leverage for this trade is 1: 28.57.

Value of the PIP: In the case of USD/JPY, the pip is represented by the variation in the 2nd decimal place, that is, 0.01 or 1% of the amount traded in the base currency represented in the cross currency.

The calculation for the PIP value will be as follows:

We are trading 200,000 dollar units, the pip is measured at the second decimal 0.01 and the TC of the USD/JPY is 85.23.

(0.01 / 85.23) * 200,000 = US$ 23.46 x pip.

Stop Loss: We are going to place a Stop Loss of 200 pips in this trade, at the level of 87.23, so the maximum possible loss will be 4692 USD (200pips x 23.46USDxpip).

Profits or Losses: Let’s imagine that the yen weakens against the dollar, this hurts us.

Your loss would be the following: (87.23 – 85.23) = 2.00, that is, there is a difference of 200 pips against you. 200 pips x 23.46 USD x pip = 4692 USD.

And what role did leverage play?

Having used a leverage increased the size of your loss, which represented 67.02% of your total trading account.

If you had not had leverage, the operation would have been like this:

If you have 7,000 USD in your account and you want to go short USD/JPY. You could only go short with US$ 7,000. At this trading volume, how much is the pip worth? Making the calculation, in this operation the value of the pip would be only 0.8213 USD x pip.

If you had lost 200 pips on this trade, your total loss would have been US$ 164.26.

What does this mean? That your 1:50 leverage magnified your loss up to 28 times more than if you had not used leverage.

What do you want to learn today?

You may also be interested in

Order Types

Order Types The stock markets, Forex, Options and others, have some elements in common. One of them are the types of orders that they allow to

Read more »

Order Types

Order Types The stock markets, Forex, Options and others, have some elements in common. One of them are the types of orders that they allow to

Read more »