Leverage is an extremely powerful tool in an experienced trader’s arsenal, but with great power, comes great responsibility. Leverage magnifies potential gains and losses, with too little leverage in the forex market, you will be wasting your time due to the low volatility. With too much leverage, forex becomes more volatile than even the equity market and you can easily lose all your money. Vantage FX offers all our clients 500:1 leverage, but this doesn’t mean you should actually use all of that leverage.
The amount of leverage you should use depends on three things: the volatility of the market you are trading, the style of trading you do and finally your risk tolerance. In this piece we will discuss all of these factors in more detail and help you decide what is the right amount of leverage to help you achieve your forex trading goals.
Volatility of the market
In general, the quieter the market you are trading, the more leverage you will need to use in order to achieve the same gains as a more volatile market. This is the reason leverage is available in the forex market: 1% is a big day in forex, often markets will not even move that in a single day and very rarely in one direction. Compare that to the equity market where a 5% move is often just noise and 10-20% moves in either direction aren’t uncommon.
Even in forex though, some markets are quieter than others and some markets are more or less active at different times of day. Volatility is never static either, USDCAD is an example of a pair which is often quiet, though it can get very volatile as well. EURUSD and GBPUSD tend to be very volatile, so generally you would use less leverage when trading pairs like those. Having said that, both of those pairs are very quiet during the Asian Session, so if you are a day trader in Australia who closes his trades at 4PM Sydney time; you will probably use more leverage than a day trader in the UK London trading these pairs in the European and New York sessions.
Some assets are simply too volatile to trade with any leverage. Vantage FX Broker has recently added Bitcoin to our available trading assets, but we don’t offer any leverage on Bitcoin contracts. Bitcoin is so volatile that you don’t actually need leverage to turn a profit.
Seasonality also affects volatility, forex markets tend to be rather quiet in the US Summer (June-August) and you may need to use a little more leverage during this time. Look at recent volatility on the pair you are trading, look at historical volatility, understand the prevailing market conditions and set your leverage accordingly.
Style of trading
Different styles of trading require different amounts of leverage, this isn’t so much about risk tolerance (which we will cover next), but about the size of your stop loss. Scalpers require more leverage than intraday traders, who require more leverage than trend and swing traders. Let’s take a look at the above styles of trading, as this is not about risk tolerance, we’ll assume all of our traders risk 2% per trade:
- Our scalper trades with an average stop loss of 5 pips
- Our intraday trader uses an average stop loss of 25 pips
- Our swing and trend traders use an average stop loss of 75 pips
Even though our traders are all looking to risk 2% of their account per trade, their risk in market terms varies a great deal. If they all traded the same position size, the swing and trend traders would be risking 15 times more per trade than the scalper. As such, if they are all only going to risk 2%, these traders need to make their positions smaller or larger depending on their trading style. Assuming all our trader have the same size balance to trade/invest; the scalper’s trades will need to be 5 times larger than the intraday trader, whose trades will need to be be 3 times larger than the swing trader. Our scalper is going to need considerably more leverage than our trend trader, 15 times more in fact.
Set your leverage according to the style of trader you are; while 500:1 leverage may be essential for aggressive scalping, trend traders can get by with substantially less than that. Another thing to consider is number of positions, a trader who has 5 trades open at once will need more leverage than a trade who takes things one at time. Vantage FX offers all clients 500:1 leverage, because we cater and welcome all types of traders.
Risk tolerance
This is the toughest part, though leverage is primarily dictated by market volatility and trading style, your personal capacity for taking on risk is a big factor too. Just like a trader using a 5 pip stop loss needs more leverage than a trader using a 25 pip stop loss; a trader who wants to risk 5% per trade will need more leverage than a trader is only risking 1%. No one can set your risk tolerance for you, the amount of risk you are willing to take on is determined by your psychology and your financial goals. Having said that, you should never risk more than 5% per trade, and most experts agree that just 2 or 1% is a much safer figure.
Assess your personal risk tolerance and financial goals and set your leverage accordingly.
With great power comes great responsibility
At Vantage FX, we believe all our clients should be able to trade in anyway they deem fit. We don’t believe our clients should be restricted by arbitrary limits set by us and we believe our clients are wise enough to make their own decisions. This is why we offer all our clients up to 500:1 leverage. Open a Vantage FX RAW-ECN account today and experience limitless trading with institutional grade spreads and one of the lowest commission charges in the industry.
