One of the many traps for traders just starting out is fully understanding the value of your trades and knowing how to work out the true value of your cost if you leverage FX.
It is often quoted that if you have an US dollar account the value of a lot is 0,000 USD. This is not always true.
Fx Trading
If you trade 100,000 GBPUSD, you actually trade dollars to the value of £100,000 which is at time of writing is about 3,000. There is a big difference between 0,000 and 3,000
To Leverage FX you borrow money. To calculate leverage you must first know how much you have (margin)and then you must divide that into how much you are going to trade with (the size of the lot you are going to buy, or in effect, borrow).
Therefore you must know the value of the base currency against the currency your account is in.
Let's say you have EUR20,000 and you do a trade (buy EURUSD of 100,000). Your leverage is 100,000/20,000 = 5:1. For every EUR1.00 you actually have you trade with EUR5.00. This is if your account is in euros.
To calculate your risk you need to know what currency is your account? Let's assume it is US dollar.
The problem with leverage calculations in foreign exchange is that you have to express the base currency of the currency pair you trade in the currency of your account.
Just to confirm what the base currency is: The base currency is the currency named first in the currency quotation. Example: EURUSD, euro is the base currency. Example : USDJPY, US dollar is the base currency.
An example of the base currency not being USD and the affect it has on leverage, the price of EURUSD is 1.2755/8, which means for each euro you will have to pay 1.2758 US dollars if you buy euro and if you sell euro you will receive 1.2755 US dollars. If you have a ,000 US dollar denominated trading account and buy one "standard lot" of (EUR100,000) EURUSD. The value of the transaction in US dollar terms is 7, 580. You have ,000 and therefore your leverage is 127,580 / 10,000 = 12.75:1. For each one dollar you trade .75 - you have leveraged or geared your account 12.75 times. Not 10 times as you might have thought.
To make better decisions it is important to understanding the exact amount that you trade. It is worth mentioning that if you have more than one trade open your leverage for each trade must be totaled to give you your leverage figure.
If you trade one mini lot EURUSD, GBPUSD and USDCHF, the total value of units = 30,000 (3 mini lots) and your capital is ,000.
Your leverage is thus 30,000 / 1,000 = 30:1. That's high. You have borrowed 30 times what you have.
The obvious reason people borrow more is shown in this example. If you borrow 5 times your capital, it was levered 5:1 and you made 0.00. If you borrowed ten times your capital and was levered 10:1, you would have made on the same market move ,000 or 10% of your capital. If you borrowed two times your capital 2:1, 2% and so on.
Take your time and make sure you calculate how much you are actually trading and check the leverage is a figure you are comfortable with. Remember it is always better to be able to come back and trade another day.
For more articles about leverage go to my website.
Before You Leverage FX, Understand the True Cost
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