Appropriate Leverage Levels for Forex Trading

One of the characteristics that separates new traders from experienced traders is the way each uses leverage. One reason for this is that since many starting traders recklessly abuse leverage, they lose their entire trading accounts and are not able to stay in the game long enough to actually become experienced traders. The ones that are able to use leverage responsibly are the ones that are able to construct workable trading plans that can be successfully repeated over time.

In fact, you can almost guess how a trader will use leverage based on the amount of money that is in a trading account. Newer traders tend to have smaller amounts of capital when starting and accounts with less than $5,000 tend to approach position sizes in aggressive ways. Since these accounts are much smaller, it becomes very easy for a few trades to go wrong and wipe out the account entirely. Traders with larger account sizes tend to be in less of a rush to make money and the result of that leverage tends to be approached in more conservative ways.

Protective Position Sizes

Many experienced traders advise newbies to apply leverage ratios of 10:1 or less (which means that at least $1 is deposited for every $10 in a position size). More experienced traders (and those with larger account sizes) tend to have successful trades in larger percentages. While this might seem to be something of a tautology.

 overly emotional, as though trading is impossible or even that your broker is running a scam operation. These factors can snowball and create a dangerous cycle that can lead new traders discouraged and unwilling to continue.

Leverage as Part of Your Strategy

Another key point to remember is that recklessly using leverage can even destroy what would otherwise be a solid and successful strategy. So, using leverage effectively can have a significant and direct impact on your overall profits and losses. Since no trading strategy can prepare you for changing market conditions 100% of the time, so it must always be understood that losses can be taken on at any time. The surest way of protecting against these potential changes is to always use stop losses and to keep trading sizes at conservative levels.

When constructing your trading strategy it is always a good idea to keep this simple equation in mind, based on the equity in your account:

Total Account Equity * Preferred Leverage Ratio = Maximum Trade Position Size (for all open positions combined)

So, if you are trading at the upper end of the acceptable leverage range (10:1), an account with $1,000 in total equity will never allow open positions to pass $10,000. Your preferred leverage ratio however, will vary. More conservative traders will be able to use ratios of 2 or 3 to 1, or, perhaps, no leverage at all (a ratio of 1:1). More aggressive traders can still sustain their accounts with slightly higher levels.

Of course, leverage can be managed either by adding to your account equity or by decreasing the size of your trades. Most successful traders tend to place their focus on the amount of money that is being put at risk, rather than the potential gains of a trade. Leverage is a powerful tool that can cause one losing trade to completely erase a strong of successful trades. Keeping leverage at conservative levels can help to slow losses when they do occur and can help to protect against losing streaks. Successful traders have confidence in their methods while being sensible in their profit expectations. Successful strategies generally require a sufficient amount of trading capital of sufficient capital (trading accounts worth at least $5,000) and conservative approaches to leverage (with ratios not exceeding 10 to 1).