We would like to explain what leverage in Forex is for. Understanding leverage is not as simple as knowing that with 1:2 you have twice as much money to open trades, because in reality, it is not.
Want to know why? We invite you to read on...
Table of Contents
Law of the lever
Leverage goes back a long way. Our prehistoric people, the same ones who perhaps still wielded a flint-tipped spear to bring down the occasional mammoth, also used the law of leverage to lift weights far greater than their direct strength would allow.
Give me a foothold and I will move the world.
Pythagoras 100 B.C.
The lever serves to amplify the mechanical force applied to an object to increase its distance or force traveled in response to an applied force. This amplification depends on the length of a rigid bar that is supported at a single point, as well as the distance on either side of the bar. The illustration above is demonstrative of how, by using the lever appropriately, we can maintain a force balance of 5:100.
Keep in mind that 1 lot of EURUSD costs 100,000 EUR. If the minimum that a broker allows you to trade is 0.01 lots -in Standard account-, you would need 1000 Euros to be able to trade that minimum. In addition to that, your position always opens in negative -due to the spread-so you would need significantly more, much more, to avoid incurring too much risk management. A commonly acceptable exposure of a trade within the market is considered to be between 1% and 5% of the total account balance - of loss in case the trade goes against you. With 1,000 Euros, we already told you that you could not achieve this and neither could you with 10,000. Even if you have 100,000 Euros. The only solution to this is to have much more money or... leverage.
Leverage in a financial market allows us to operate with the same amount of money in our account, as if we had an amount proportional to the leverage offered. But this is a very biased view of reality.
We usually say that when we leverage ourselves, the broker "lends" us his money "for free" so that we can invest it in the market. But this loan is neither free nor is it a loan. In reality, what the broker is doing is providing us with the necessary leverage so that you and I can participate in a market in which the minimum bid is 0.01 on 100,000 units of the base currency.
But the fact that it provides leverage does not mean that it is multiplying our money by 500, 1,000 or 2,000. What the broker's leverage does is that, every time we double the leverage, the broker, in return, allows us to halve the spread or in other words, the amount that the broker sets aside to open trades. And this is the advantage of leverage.
Leverage does not multiply the capital but rather divides the margin to increase it, thus enabling us to open more operations.
Common leverage mistakes
Think now -it won't be difficult for you to understand-, that nobody is going to offer you the pot of gold at the end of the rainbow. Brokers, especially those who act as counterparties to our operations -also called Market Makers-, together with a lot of bonuses for opening accounts -don't use them, as they give a false sense of security-, offer us novices to "multiply our money", all thanks to leverage. Wonderful, praise be to the broker!
The catch is that, for novices like us, this leverage also gives us the feeling that we can use it to maximize profits and not to increase our "margin of maneuver", which is what it exists for.
If our operations are overleveraged thanks to the wonderful 1:1000 or 1:2000 that we are "given", the broker will win at the moment, for that uncertain security, we enter with more lotaje than due to the operations. This will cause that, if we make a mistake -and Murphy says that we will-, our margin will be reduced at a speed proportional to the loatage/leverage ratio. This, if we are winners because we have a winning strategy, will allow us to beat the market more. But in reality we are not winners, we are novices, little minnows prowling the jaws of a hungry great white shark. When we have been wrong enough times, our margin will eventually drop to the Stop Out point, which is the margin at which our broker reserves the right to close all open positions. And this ensures that the account will be burnt out, finished, defunct, caput... your money making spree is over. Your account is in the hands of Saint Peter.
Uses of leverage in Forex
The margin can be measured as a percentage of our account's Equity -account balance plus the profit or loss at stake-. This percentage gives us a realistic view of the health of our account. Therefore:
Health (Margin Level%) = (Equity/margin) * 100
By applying double leverage, we halve the divisor of this formula. In this way, we move away the theoretical moment of our demise, because we are friends of St. Peter, but we only want to see him by videoconference.
In the case of a martingale bot -like Ducibus Pro-, increasing the leverage from 1:500 to 1:1000 -the broker goes from "lending" us 500 for every 1 to 1000 for every 1 of the currency we have-, will allow you some more operations, depending on how close to death you are, but no more than 2 or 3 more operations. By increasing the leverage to 1:2000, we would increase the "fregaos" in which our beloved Ducibus can be involved in 2 or 3 more operations. And watch out! This will only work when the algorithm involved is balanced in its operation, i.e. one or two of the Ducibus algorithms are in these advanced martingale cycles and not all three. Fortunately and contrary to other bots already described similar to Ducibus, we have put under control the number of algorithms that can be involved in these messes and we have limited it to 2 out of 3 -with the Classic Light mode-, with the possibility to disable any of the algorithms independently.
So when we recommend leverage for use with our bots, it is not on a whim that you increase your risk proportionally, but because of the need we have, due to the aggressive type of trading of a martingale bot, to reduce risk by increasing margin.
In the same way, increasing the capital when the bot is in trouble, will not bring more than a little more margin to your operation. This is not to say that this is a bad thing, on the contrary, it can allow you some movement. We will show you how to use this hedging strategy as if it were a fire extinguisher to put out a fire. But we will insist that you only do so when the market conditions are right and the mathematical hope that the martingale will end up in profit is in our favor. And this, after all, is the technical analysis of the chart.
In short, doubling the leverage does not double the number of hedges of the Ducibus bot, because the lotting of each new operation is exponential - through the lotExponent - and not arithmetic. And this is very dangerous. We repeat, very dangerous. Do you understand what very dangerous means?
A practical example of leverage
Below is a calculation of the number of martingales that can be performed given specific parameters for different algorithms and balances.
As you can see, the maximum number of martingales -we have called them lives because we are cool like that-, has nothing to do with the balance. In fact, using the same parameters, the difference of a balance five times higher, is to be able to open between 3 and 5 martingales more, depending on parameters such as lotExponent. So, watch out for the fire extinguisher! Sometimes it does not extinguish fires, but rather wipes out all traces of numerical life in our trading balance. And we don't want that...
Trading with Ducibus requires being prepared, knowing how to take risks and understanding how the tool works. To limit the danger and keep it as low as possible, you must learn what you have in your hands. We already do and we continue to evolve day by day. What are you going to do?
Our advice: Learn as much as you can. And when you have learned, question your knowledge and learn again. Did you want financial freedom? You will achieve it, but every reward requires effort. There are no magic formulas, but there are shortcuts.
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