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What is Your Optimal Forex Trading Leverage

 

Leverage results from using borrowed capital as a funding source when investing to expand the firm's asset base and generate returns on risk capital. Leverage is an investment sytrategy of using borrowed money — specifically, the use of various financial instruments or borrowed capital — to increase the potential return of an investment…. Investopedia

I was asked recently, “What is the optimal leverage to use trading with The Amazing Trader program?  I thought about my reply for some time as there is not a one size fits all answer as it depends on several factors.  

So I decided to ask for input from some of our subscribers on the optimal leverage in general. I wanted to go beyond just my opinion and see the perspective of other forex traders who trade with margin with their brokers. The following is from a veteran forex trader who subscribes to the Amazing Trader:

From a Veteran Forex Trader

To me, leverage is a subjective thing that depends on the moment.  I always think about what my doctor tells me when discussing blood pressure:  "If your heart is pounding, you are sweating, you can't sit still and you are worrying all the time, then your blood pressure is too high."

The same thing goes for leverage, and it depends on your time frame and the trade situation.  For AT (Amazing Trader) trades on the 5m and 15m time frames for instance, you are probably sitting in front of the screen and can quickly close a trade that has gone awry.  You also have the advantage (if you are psychologically prepared to take it) of knowing when to get out, based on AT price levels.  You then adjust your leverage based on how much cash you have and your trade size.

If you are working on longer time frames, then you might not be in front of the screen all the time.  "Tiny leverage", to me, could mean being able to withstand several hundred pips in the wrong direction without worry.

The brokers all say you should risk no more than 2-4% of your equity per trade.  That's not a bad place to start.

From Jay Meisler:

I suggest a trader lower his/her risk (e.g.1% of equity per trade or lower) until he/she shows the ability to produce profits consistently. The key word here is “

One way to do this is to get access to a program such as The Amazing Trader and its strategies designed with a goal of highlighting high probability trading opportunities. Once this is accomplished, leverage can be increased so there is a greater risk/reward per trade.  I call this trading from 

Illustration: $5000 account trading the                                                                                                                                                                                                                       -   # pips at risk  -

Leverage

Size Trade

Equity Risk

# pips

# pips

# pips

5:1

25,000

1% equity ($50)

20

10

5

10:1

50,000

2% equity ($100)

40

20

10

20:1

100,000

4% equity ($200)

80

40

20


As you can see by this table, the higher the leverage, the less leeway in terms of number of pips at various levels of equity risk per trade. In other words, at a 20:1 leverage, it would take just a 20 pip stop being triggered to lose 4% of capital.

Remember that with increased profit potential leverage comes an increase in the risk of loss. As the table above shows, the higher the leverage the less leeway the trade has to work. In any case, a trader should never put his/her capital at risk to the extent that it would make it difficult to continue trading if proven wrong. In other words, capital preservation and prudent money management are keys to living to trade another day.

So the bottom line is there is not a clear answer to what is the optimal leverage as much depends on many factors, such as risk tolerance, whether a trader opts to keep a tight leash on risk (e.g. sitting in front of a screen) or chooses to put on a trade using a longer time frame, etc. In any case, if you have to worry about losing too much on a trade your leverage is too high.

Coming soon: Where to Place Your Stop

Jay Meisler

www.theamazingtrader.com

 

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