The Concept of Leverage
Many beginning traders don’t fully understand the concept of leverage. Basically, if you have a start up capital of $5,000 and if you trade on a 1:50 margin you can effectively control a capital of $250,000.
However, a two percent move against you and your capital is completely wiped out. If you are a beginning trader you should not use more than 1:20 margin until you get comfortable and profitable and then and only then you can attempt to use higher margins.
What does 1:20 margin mean? It means that with your $5,000 you will control a capital of $100,000. Let’s say you are trading EUR/USD and by using our entry strategy you have decided to enter the trade on a long side. That means that you are betting that USD will depreciate against Euro. Let’s say current EUR/USD rate is 1.567.
Again, if your trading capital is $5,000 and you are using 1:20 leverage you will effectively be exchanging $100,000 to Euros. If the current rate is 1.567 you will receive 100,000/1.567 = 63,816 Euros.
If the trade goes in your direction the margin will work in your favour and 1% decline in USD will mean 20% increase in your start up capital. So if EUR/USD rate moves from 1.567 to 1.583 you will be able to exchange your 63,816 Euros back to $101,000 for a profit of $1,000. Since your start up capital was $5,000 it is effectively a 20% increase in your account. However, if the trade went against you and USD appreciated 1% vs. Euro your account would be reduced to $4,000. That would not have happened as our strategy has built in hard stops to prevent such an outcome.