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Article / 19 December 2014 at 1:18 GMT

How much trading leverage is too much?

Managing Director / Technical Research Limited
New Zealand
  • Trading successfully in the long term requires mastering trading leverage
  • FX “promoters” boldly claim that you can trade up on up to 50:1 leverage
  • But many professional traders typically operate on leverage in the vicinity of 3:1

By Max McKegg

One of the issues that confronts all traders, and which is perhaps especially significant for novice traders, is how much leverage to use when trading forex. Although there is no one “right answer” to this question, there are some very important guidelines.

FX “promoters” (or in many instances, hucksters) boldly advocate a principal advantage of FX trading being that you can trade up on up to 50:1 leverage, and that this enables you to make a lot of money very quickly. The promoter (a quick review of the internet shows there are is no lack of them) emphasizes only one side of the ledger – the profit component. The reason for this is obvious!

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Hit and miss ... trading on 50:1 leverage or anything even remotely like it is akin to a novice tennis player taking on Roger Federer.

Trading on 50:1 leverage (or anything even remotely like this) is akin to a school boy driving a formula one racing car, or a club tennis player taking on Roger Federer! The leverage is far too high and allows no margin of safety, nor the placement of strategically positioned stop losses but those based solely on financial considerations. In short, trading on such leverage is more akin to gambling in a casino with no relative advantage. It is only a matter of time, before the novice trader blows-up his trading account.

Just as charlatans claiming pills and potents are elixirs, offering cures for all our ills and eternal youth for all – beware the FX promoter claiming extreme trading leverage is the golden key to riches.

Many veteran trading professionals will tell you that trading successfully over the long term requires mastering trading leverage. This means utilising sufficient leverage to enable you to maximise your trading profitability but also minimising trading leverage so that you never take “a big hit’ and that any one loss or series of losses does not compromise your trading capital and your participation “in the game”.

Trading is a very much long game and this requires effective risk/money management and determining the right leverage for any given trading situation is an important part of this.
Although trading leverage will vary dependent upon stop loss placement and perhaps even the confidence a trader has in a given trading position, as a broad, “rule of thumb” many professional traders will typically operate much of the time on trading leverage in the vicinity of 3:1.

Such leverage may seem incredibly low to the novice trader (and most certainly to the rabid FX promoter!). But whilst such leverage does not provide “instant” outlier profits, what it does do is the following:
  • It allows the trader to withstand a series of relatively small and manageable trading losses, since collectively they do not have a material effect on the trader’s capital (as the professional trader knows that a series of losses can never be allowed to compromise his/her annual trading performance), and
  • It enables the trader to place his stop loss at a technically/strategically appropriate level that does not compromise his/her objective technical analysis of the market. In other words, the size of the trading position is made to “fit” the stop.
Trading leverage is a powerful tool but if not properly respected, will likely eventually prove a trader’s downfall.

– Edited by Robert Ryan

Max McKegg is managing director of Technical Research Limited. Follow Max here or post your comment below to engage with Saxo Bank's social trading platform.

For more on forex, click here.



3y
Ghulam Muhiuddin Ghulam Muhiuddin
Thanks Max Excellent Article on leverage.
3y
Max McKegg Max McKegg
thanks
3y
cala bona cala bona
excellent!

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