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How to Calculate Leverage, Margin, and Pip Values in Forex. Although most trading platforms calculate profits and losses, used margin and useable margin, and account totals, it helps to understand how these things are calculated so that you can plan transactions and can determine what your potential profit or loss could be. Leverage and Margin. Most forex brokers allow a very high leverage ratio, or, to put it differently, have very low margin requirements. This is why profits and losses can be so great in forex trading even though the actual prices of the currencies themselves do not change all that much—certainly not like stocks. Stocks can double or triple in price, or fall to zero; currency never does. Because currency prices do not vary substantially, much lower margin requirements is less risky than it would be for stocks. Before 2010, most brokers allowed substantial leverage ratios, sometimes up to 400:1, where a $100 deposit would allow a trader to trade up to $40,000 worth of currency. Such leverage ratios are still sometimes advertised by offshore brokers. However, in 2010, US regulations limited the ratio to 100:1. Since then, the allowed ratio for US customers has been reduced even further, to 50:1, even if the broker is located in another country, so a trader with a $100 deposit can only trade up to $5000 worth of currencies. In other words, the minimum margin requirement is set at 2%. The purpose of restricting the leverage ratio is to limit the risk. The margin in a forex account is often referred to as a performance bond , because it is not borrowed money but only the amount of equity needed to ensure that you can cover your losses. In most forex transactions, nothing is actually being bought or sold, only the agreements to buy or sell are exchanged, so borrowing is unnecessary. Thus, no interest is charged for using leverage. So if you buy $100,000 worth of currency, you are not depositing $2,000 and borrowing $98,000 for the purchase. The $2,000 is to cover your losses. Thus, buying or selling currency is like buying or selling futures rather than stocks. The margin requirement can be met not only with money, but also with profitable open positions. The equity in your account is the total amount of cash and the amount of unrealized profits in your open positions minus the losses in your open positions. Total Equity = Cash + Open Position Profits - Open Position Losses. Your total equity determines how much margin you have left, and if you have open positions, total equity will vary continuously as market prices change. Thus, it is never wise to use 100% of your margin for trades—otherwise, you may be subject to a margin call . In most cases, however, the broker will simply close out your largest money-losing positions until the required margin has been restored. The leverage ratio is based on the notional value of the contract, using the value of the base currency, which is usually the domestic currency. For US traders, the base currency is USD . Often, only the leverage is quoted, since the denominator of the leverage ratio is always 1. The amount of leverage that the broker allows determines the amount of margin that you must maintain. Leverage is inversely proportional to margin, which can be summarized by the following 2 formulas: Leverage = 1/Margin = 100/Margin Percentage. To calculate the amount of margin used, multiply the size of the trade by the margin percentage. Subtracting the margin used for all trades from the remaining equity in your account yields the amount of margin that you have left. To calculate the margin for a given trade: Margin Requirement = Current Price ? Units Traded ? Margin. Example—Calculating Margin Requirements for a Trade and the Remaining Account Equity. You want to buy 100,000 Euros (EUR ) with a current price of 1.35 USD, and your broker requires a 2% margin. Required Margin = 100,000 ? 1.35 ? 0.02 = $2,700.00 USD. Before this purchase, you had $3,000 in your account. How many more Euros could you buy? Remaining Equity = $3,000 - $2,700 = $300. Since your leverage is 50 , you can buy an additional $15,000 ( $300 ? 50 ) worth of Euros: 15,000 / 1.35 ? 11,111 EUR. To verify, note that if you had used all of your margin in your initial purchase, then, since $3,000 gives you $150,000 of buying power: Total Euros Purchased with $150,000 USD = 150,000 / 1.35 ? 111,111 EUR. Pip Values. Because the quote currency of a currency pair is the quoted price (hence, the name), the value of the pip is in the quote currency. So, for instance, for EUR/USD, the pip is equal to 0.0001 USD, but for USD/EUR, the pip is equal to 0.0001 Euro. If the conversion rate for Euros to dollars is 1.35, then a Euro pip = 0.000135 dollars. Converting Profits and Losses in Pips to Native Currency. To calculate your profits and losses in pips to your native currency, you must convert the pip value to your native currency. When you close a trade, the profit or loss is initially expressed in the pip value of the quote currency. To determine the total profit or loss, you must multiply the pip difference between the open price and closing price by the number of units of currency traded. This yields the total pip difference between the opening and closing transaction. If the pip value is in your native currency, then no further calculations are needed to find your profit or loss, but if the pip value is not in your native currency, then it must be converted. There are several ways to convert your profit or loss from the quote currency to your native currency. If you have a currency quote where your native currency is the base currency, then you divide the pip value by the exchange rate; if the other currency is the base currency, then you multiply the pip value by the exchange rate. Example—Converting CAD Pip Values to USD. You buy 100,000 Canadian dollars with USD, with the conversion rate at USD/CAD = 1.200 . Subsequently, you sell your Canadian dollars when the conversion rate reaches 1.1000 , yielding a profit of 1.1200 - 1.1000 = 200 pips in Canadian dollars. Because USD is the base currency, you can get your profit in USD by dividing the Canadian value by the exit price of 1.1 . 100,000 CAD ? 200 pips = 20,000,000 pips total. Since 20,000,000 pips = 2,000 Canadian dollars , your profit in USD is 2,000 / 1.1 = 1,818.18 USD . However, if you have a quote for CAD/USD , which is equal to 1/ 1.1 = 0.9090909090909 , then your profit is calculated thus: 2000 ? 0.9090909090909 = 1,818.18 USD , which is the same result obtained above. For a cross currency pair not involving USD, the pip value must be converted by the rate that was applicable at the time of the closing transaction. To find that rate, you would look at the quote for the USD/pip currency pair, then multiply the pip value by this rate, or if you only have the quote for the pip currency/USD, then you divide by the rate. Example—Calculating Profits for a Cross Currency Pair. You buy 100,000 units of EUR/JPY = 164.09 and sell when EUR/JPY = 164.10 , and USD/JPY = 121.35 . Profit in JPY pips = 164.10 – 164.09 = .01 yen = 1 pip (Remember the yen exception: 1 JPY pip = .01 yen .) Total Profit in JPY pips = 1 ? 100,000 = 100,000 pips . Total Profit in Yen = 100,000 pips / 100 = 1,000 Yen. Because you only have the quote for USD/JPY = 121.35 , to get profit in USD, you divide by the quote currency's conversion rate: Total Profit in USD = 1,000 / 121.35 = 8.24 USD. If you only have this quote, JPY/USD = 0.00824 , which is equivalent to the above value, you use the following formula to convert pips in yen to domestic currency: How Much Leverage Should I Use? In my last article, I explained the concepts of leverage, margin and position sizing in Forex , concluding with the importance of knowing the “true leverage” of your trading account at any time, as it has a direct bearing on your risk of suffering a severe or catastrophic loss. In this article, I am going to look for some answers to a question that every trader wrestles with – how much leverage to use in trading. The measure I am going to use is “true leverage”, which is a measure of the total maximum loss you are exposed to as a proportion of your account equity. The Key Impact of Leverage. To have any true leverage at all, i.e. to have a leverage ratio of more than 1:1, means that you can at least in theory lose an amount exceeding your deposit. Unlike the stock market, in Forex, extremely large moves are very rare, and currencies rarely disappear completely, which is why it is generally accepted to be a less risky market. Companies fail and go bankrupt sending their shares to zero, but countries very rarely disappear. However, becoming liable for an amount greater than your deposit in Forex is not just a theoretical issue, even when using relatively low leverage. Consider the example of the Swiss Franc in January 2015, an episode where many brokers shut down their trading platforms, locking traders out of their accounts for about an hour. During this period the Swiss Franc was quoted up by more than 31% by many brokers, meaning anyone with a leveraged position from a trade against the Swiss Franc by a factor of more than 3:1 would have come back online to find their account wiped out! Even worse, if you were leveraged by more than that, your broker could have argued that they could not execute your stop loss until a price which was more than your total deposit could cover, and sue you for the balance. There were highly leveraged traders with deposits of perhaps a few thousand dollars who received letters from their brokers demanding 5 or even 6 figure sums. This is a topic for another time, but it puts the potential danger of leverage into stark relief. Leverage in Trading and Business. By law, the maximum leverage that can be offered by stockbrokers in the U.S.A. is 2:1 by end of day of purchase. As a general, companies are regarded as over-leveraged if they reach a leverage ratio is excess of 1:1.3. Yes, that is 1.3, not 13! As always, it should be more instructive to look at a real-life trading scenario in trying to understand the risks and opportunities leverage can offer. Risk & Leverage. Most Forex traders trade with a stop loss and risk a fixed percentage of their account equity or initial deposit on each trade they take. To be profitable, they must either win more than half of their trades if wins average the same as losers, or proportionately more if the number of winning trades is less than half of all the trades taken. Let’s look at the most positive scenario statistically: a trader that wins 58.33% of their trades where the average winner cancels out the average loser. Such a trader has a positive expectancy per trade of 8.33%, which is a very impressive achievement if it is achieved with a win rate over 50%. This means that 41.77% of trades will be losing trades, but that is far from being the end of the story. Over a large timeframe, there will be many runs of consecutive losers that go far beyond 4 or 5 trades. If you don’t believe me, try this experiment: Pick up two dice, understanding your probability of rolling a total from 8 to 12 has a 41.77% probability. Roll the dice one thousand times and record how many times you roll between 8 and 12. If you count the streaks where you roll those numbers, you are likely to find that your longest streak is about 9 consecutive rolls. It has a meaningful chance of being higher. Imagine now the same for a trader who is using quite high leverage to risk 2% of their initial deposit per trade, and getting the same (unrealistic) results. If this streak of 9 losing trades is met at the beginning, they will be down 18%. To get back to even, the trader must grow his account by 22%. Let’s now look at a realistic trading scenario: a trader who wins 40% of their trades, but where the average winner makes double the average loser. This produced a high positive expectancy of 20% profit per trade, but when we look at the probability of losing streaks, the statistics are more alarming than the previous example. A maximum losing streak of 14 trades is the most probable result with a good chance of a streak extending to 20 rolls. Markets are Not Dice! The problem with these comparisons is that financial markets do not produce probabilistically “normal” distributions of winning and losing streaks. Markets are statistically more extreme and a trend following strategy targeting profits of 2 to 1 with a win rate of 40% will typically produce larger streaks of losing trades. A good solution to this problem is to conduct a back test over a long period covering all kinds of different market conditions, using hundreds and ideally thousands of samples. Then instead of looking for a streak of losers, look for the worst draw-down, a period where the losers are worse than the winners. Let’s say you have a worst draw-down of 25 units of risk (a unit being equal to a single losing trade). Double it. You now have a “worst-case scenario” of 50 units of loss. Now consider the fact that if you lose more than 25% of your trading account, you need a much larger gain just to get back to where you started. As a rough rule, you might decide to aim for never being down by more than 25%. Under a worst-case scenario of a 50-unit drawdown, that would equal roughly a 0.5% risk per trade. The final question then becomes whether you have enough money to accommodate such a risk. For example, if the widest stop loss you ever use is 75 pips, then to “afford” that you must deposit at least $1,500 with a broker offering trading in micro-lots. If you had 4 trades open simultaneously, that would give you a maximum true leverage of a little less than 3 to 1. Risk of a One-Off Event. Don’t forget that while we’ve been dealing with managing cumulative risk over a long period in the above paragraphs, the use of a true leverage greater than 3 to 1 has been proven in recent history to be risky enough to wipe out a Forex account in seconds. Ideally, you should use as little leverage as possible, and determine how much you can afford to use by estimating your worst-case drawdown, deciding how much drawdown you could possibly tolerate. Adam Lemon. Adam is a Forex trader who has worked within financial markets for over 12 years, including 6 years with Merrill Lynch. He is certified in Fund Management and Investment Management by the U.K. Chartered Institute for Securities & Investment. Learn more from Adam in his free lessons at FX Academy. Registration is required to ensure the security of our users. Login via Facebook to share your comment with your friends, or register for DailyForex to post comments quickly and safely whenever you have something to say. 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Before deciding to trade Forex or any other financial instrument you should carefully consider your investment objectives, level of experience, and risk appetite. We work hard to offer you valuable information about all of the brokers that we review. In order to provide you with this free service we receive advertising fees from brokers, including some of those listed within our rankings and on this page. While we do our utmost to ensure that all our data is up-to-date, we encourage you to verify our information with the broker directly. Risk Disclaimer: DailyForex will not be held liable for any loss or damage resulting from reliance on the information contained within this website including market news, analysis, trading signals and Forex broker reviews. The data contained in this website is not necessarily real-time nor accurate, and analyses are the opinions of the author and do not represent the recommendations of DailyForex or its employees. Currency trading on margin involves high risk, and is not suitable for all investors. As a leveraged product losses are able to exceed initial deposits and capital is at risk. Before deciding to trade Forex or any other financial instrument you should carefully consider your investment objectives, level of experience, and risk appetite. We work hard to offer you valuable information about all of the brokers that we review. In order to provide you with this free service we receive advertising fees from brokers, including some of those listed within our rankings and on this page. While we do our utmost to ensure that all our data is up-to-date, we encourage you to verify our information with the broker directly.