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Create Date: 2008-08-29 21:44:45 | Popularity Level: 26 |
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2008-08-29 21:53:10
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Leverage the Killer
Most professional traders and money managers trade one standard lot for every $50,000 in their account.
If they traded a mini account, this means they trade one mini lot for every $5,000 in their account.
Let that sink into your head for a couple seconds.
If pros trade like this, why do less experienced traders think they can succeed by trading 100K standard lots with a $2,000 account or 10K mini lots with $250?
No matter what the forex brokers tell you, don’t ever open a “standard account” with just $2,000 or a “mini account” with $250. The number one reason new traders fail is not because they suck, but because they are undercapitalized from the start and don’t understand how leverage really works.
Don’t set yourself up to fail.
We recommend that you have at least have $100,000 of trading capital before opening a “standard account”, $10,000 for a “mini account”, or $1,000 for a “micro account”.
So if you only have $60,000, open a “mini account. If you only have $8,000, open a “micro” account. If you only have $250, open a “demo account” and stick with it until you come up with the additional $750, then open a “micro account”.
If you don’t remember anything else in this lesson, I plead that you at least remember what you just read above.
Okay, please re-read the previous paragraph and ingrain it in your memory. Just because brokers allow you to open an account with only $250 doesn’t mean you should and I’m going to explain why.
I believe most new traders who open a forex trading account with the bare minimum deposit do so because they don’t completely understand what the terms “leverage” and “margin” really are and how it affects their trading.
It’s crucial that you’re fully aware and free of ignorance of the significance of trading with leverage. If you don’t have rock solid understanding of leverage and margin, I guarantee that you will blow your trading account.
Leverage Defined
The textbook definition of “leverage” is having the ability to control a large amount of money using none or very little of your own money and borrowing the rest.
For example, in forex, you can control $100,000 with a $1,000 deposit. Your leverage, which is expressed in ratios, is now 100:1. You’re now controlling $100,000 with $1,000.
Let’s say the $100,000 investment rises in value to $101,000 or $1,000. If you had to come up with the entire $100,000 capital yourself, your return would be a puny 1% ($1,000 gain / $100,000 initial investment). This is also called 1:1 leverage. Of course, I think 1:1 leverage is a misnomer because if you have to come up with the entire amount you’re trying to control, where is the leverage in that?
Fortunately, you’re not leveraged 1:1, you’re leveraged 100:1. You only had to come up with $1,000 of your money, so your return is a groovy 100% ($1,000 gain / $1,000 initial investment).
Now I want you to do a quick exercise. Calculate what your return would be if you lost $1,000.
If you calculated it the same way I did, which is also called the correct way, you would have ended up with a -1% return using 1:1 leverage and a WTF! -100% return using 100:1 leverage.
You’ve probably heard the good ol’ clichés like “Leverage is a double-edge sword.” or “Leverage is a two-way street.” Well….as you can see, these clichés weren’t lying. |
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