How Much Forex Leverage You Need to Day Trade

Day trading scenarios for how much leverage you will need

how much leverage to use for forex day trading
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Forex brokers offer leverage up to 500:1, and sometimes even 1000:1, outside the US. US forex brokers offer up to 50:1 leverage. As a forex day trader you will utilize leverage to some extent, but how much is enough? Does it matter if you use 25:1 or 200:1 (if available)? By looking at scenarios of how different traders trade, you'll get an idea of how much forex leverage you need. When you open a live trading account you can then stipulate how much leverage you would like.

What Is Leverage

Leverage is essentially the ability to trade based on credit. Currencies are bought and sold in lots, or increments, called micro, mini and standard lots. A micro is 1000 worth of currency, a mini is 10,000 and a standard lot is 100,000 worth of currency. 

Assume you open a forex account and deposit $500 (see Minimum Capital Required to Day Trade Forex). This deposited amount is less than the smallest position you take in the forex market, which requires you buy/sell at least 1000 worth of currency (micro lot). If you open an account with less than $1000, you will require leverage or you can't trade. 2:1 leverage increased the capital you have to trade $1000 ($500 x 2), and 5:1 leverage gives you $2500 ($500 x 5). Leverage allows you take trades that cost more than you have in your account. 

The cost of a trade is how many lots you opt to buy/sell. Your profit or loss is determined by how those currencies move once you are in a trade.

Profit and losses will be discussed later. 

Even if you open an account with more than $1000, you will likely still want leverage in order to day trade effectively. $1000 allows you trade one micro lot at a time. With 5:1 leverage you will be able to take trades that cost up to $5000 ($1000 x 5), or 5 micro lots.

Even though you are trading a block of currency that is worth more than your account is worth, you get to decide how much you make or lose on a trade (most of the time, but catastrophe can occur—that is discussed near the end of the article). 

Leverage Pros and Cons

Leverage magnifies day trading profits and losses. Let's look at an example to see how. 

The most commonly traded forex pair for day traders is the EUR/USD. The forex market moves in price increments called pips. A one pip move in the EUR/USD, when trading a micro lot, results in a $0.10 profit or loss on your position.

Assume you are willing to risk seven pips on a trade, and you have $1000 in your account. You are trying win 15 pips. You are trading one micro lot.

If lose 7 pips you will lose 7 x $0.10 = $0.70, or 0.07% of your deposited capital ($1000).

If you win 15 pips you will make 15 x $0.10 = $1.50, or 0.15% of your deposited capital ($1000).

Now assume you have 15:1 leverage. You can now take a trade up to 15 micro lots ($15,000 worth of currency).

If lose 7 pips you will lose 7 x $0.10 x 15 micro lots = $10.50, or 1.05 % of your deposited capital ($1000).

If you win 15 pips you will make 15 x $0.10 x 15 micro lots = $22.50, or 2.25% of your deposited capital ($1000).

Everything has been magnified due to leverage. Because you were able to take a larger position, your losses and profits are bigger, compared to if you didn't use leverage. 

If you have 50:1 leverage available to you, that doesn't mean you always need to take a position that is 50 times larger than your deposited capital. Doing so would actually be quite foolish. Rather, you only utilize the leverage you need, which is discussed in the next section. 

Utilizing leverage means you can lose more than you deposited. Even if you take precautions to manage your risk, a major event could cause you to lose much more than anticipated. If you lose more than you deposited, you will have a debt to your broker. 

Factors That Affect Forex Leverage Requirements

How much forex leverage you need is determined by the typical trades you take, how much you are willing to risk of your account on a single trade.

Knowing the "typical trade" you will take means you have a strategy that tells you where to enter a trade and where to place a stop loss. A stop loss gets you out of a losing trade if the market doesn't do what you expect it to. This is your trade risk.

You also need to know your account risk on each trade. This is a set number, which should ideally be a fixed percentage of your account. For example, if you risk 1% of your deposited capital, and you have $6500 in your account (not including leverage), then you can risk $65 on each trade (0.01 x $6500).

Based on your trade risk and account risk you can calculate the position size that is ideal for that trade and for your account risk. Position size is how many lots you buy or sell. The position size tells you how much leverage you need. 

How Much Forex Leverage to Use

Here are several scenarios that show how much leverage a day trader may require. 

Assume a day trader has a $5000 account and typically risks about seven pips on each trade. They are willing to risk 1% of their account, which equates to $50 per trade. 

To figure out the position size, take $50/$0.70 (it's $0.70 because each micro lot is worth $0.10 per pip, and we are willing to risk 7 pips). That results in 71. That means this trader can take a position size of 71 micro lots, which is worth about $71,0000, and stay within their risk parameters. 

The trader has $5000 in their account, so in order to take this trade they require 14.2:1 leverage (71,000/5000). To provide a bit of flexibility, round this up to 20:1. If multiple trades are taken at the same time, multiply the required leverage by how many trades are taken at the same time. 

Some day traders may wish to give their trades more room. In other words, their stop loss is further away from their entry point. 

If the same trader above used a 20 pip stop loss, then $50/$2 (it's $2 because 20 pips x $0.10 per pip equates to $2 of risk per micro lot) means the trader can trade 25 micro lots. That is $25,000 worth of currency, which means the trader requires at least 5:1 leverage on their $5000 account in order to take this trade. Again, if you take multiple trades at one time, multiple the leverage by how many trades you take a once. Also, round up the leverage to give yourself some flexibility.

These scenarios accommodate most day traders. That means most forex day traders will need between 5:1 and 15:1 leverage, minimum. If taking multiple trades at the same time, and to accommodate a bit of flexibility in the trades taken, utilizing 50:1 leverage is fine. The leverage is there if needed, but you don't have to use it. As shown above, typically you will only utilize 5:1 to 15:1 leverage, but having a bit more doesn't hurt. 

Let's look at one more extreme case. Say a trade has a $10,000 account and wants to aggressively trade in and out of the market quickly. They are willing to risk 5 pips per trade and 2% of their account ($200 risk per trade). To accommodate this style of trading, this trader will need more leverage.

$200/$0.50 (which is 5 pips x $0.10 per pip) = 400 micro lots, which is 40 mini lots, 4 standard lots or 400,000 worth of currency. Taking a position of 400,000 requires 40:1 leverage on the trader's $10,000 account. 50:1 leverage will provide a bit of flexibility. If trading in the US, 50:1 leverage is the most the trader can access, therefore they won't be able to take multiple trades at the same time with this type of strategy. When leverage is this high it is once again important to point out of the risk.

The Real Danger of Day Trading With High Leverage

When day trading, the smaller your stop loss and the more you are willing to risk of your account, the greater your risk of catastrophic loss. 

The trader above is holding a $400,000 position, expecting to contain their loss to 5 pips. That is not always possible. A scheduled or surprise news announcement can make exiting a trade impossible, resulting in an eventual loss that is many times the expected loss. 

Such events occur with some regularity. On October 7, 2016 the British Pound plunged more than 620 pips against the US dollar (and other currencies) in minutes. Liquidity dried up and there was nowhere to get out of losing trades. Day traders with positions when the drop happened may have been expecting only a loss of five pips, but may have actually taken losses of 200 pips or more in various GBP pairs simply because that was the nearest price available price to trade at. In order to get out of a trade, someone else must be willing to transact at that price. In this scenario, the trader was expecting to lose $200 if the price slid five pips against her. Instead, the nearest exit ended up being 200 pips away, which means they lost 40 times more than expected, or $8000 ($200 x 40). The trader thought they were only risking 2% of their account; instead, they lost 80% because the market moved so quickly that they couldn't get out of their trade as planned. Some traders may have taken even larger losses of 300, 400 or 500 pips during this event. In such a case, the trader would owe money to their broker, since they lost more than they have in the account. 

Beware of leverage, as it can be catastrophic if you can't exit as planned. Keeping risk to less than 1% of your account and not trading during scheduled news events helps reduce the probability of a catastrophic loss, but even these steps don't eliminate the risk. On the flip side, leverage provides a way to potentially make more money than without leverage.

Only day trade with capital you can afford to lose. 

Final Word on How Much Forex Leverage to Use

Use the scenarios above to help figure out how much leverage you will need. Input your account size, how much you are willing to risk (percentage of account) and how far your stop loss typically is from your entry point. The stop loss may vary from trade to trade, therefore, always take a bit more leverage than you actually need when opening your account. This allows for some flexibility, and if you take two or three trades at one time, you will need to double or triple your leverage requirements. 

50:1 is more than enough leverage for day trading. If you take 50:1 leverage that doesn't mean you have to use it all. 

As shown, using high leverage, even in a seeming risk-controlled way, can result in catastrophic losses in unforeseen market conditions. Sometimes it is not possible for your stop loss order to get you out at the price you want, resulting in a much larger loss than expected. Scenarios do occur where you may owe a large debt to your forex broker because you lost more on a trade than you deposited.

Use leverage wisely, and be aware of its risks. While leverage magnifies gains, it also magnifies losses.