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Position Sizing And Leverage

Position sizing in forex can be confusing because it is not straightforward like it is in the stock market. In forex, most brokers have preset minimum lot sizes.

.01 = micro lot (1000 units of a currency)

.1 = mini lot (10,000 units of a currency)

1 = standard lot (100,000 units of a currency)

Currencies are usually quoted using 4 decimal places. This is why leverage is used to make movements in these markets a worthwhile effort.

1 pip is the smallest movement of a currency. In the stock market you would say “my stock is higher by 20 cents”, in the forex market you would say, “the EUR/USD is up 20 pips” (100 pips is equivalent to a movement of 1 cent with the exception of a few pairs like USDJPY).

Pip stands for Percentage In Point or Price Interest Point.

How much you make or lose depends on your size:

1 standard lot: $10 per pip. +5 pips = +$50.

1 mini lot: $1 per pip. +15 pips = +$15.

1 micro lot: $.10 per pip. +30 pips = +$3.00.

So you are long 3 mini lots and you gain 10 pips, how much profit is that? That is a $30 profit.

Leverage:

Depending on your broker, your typical margin allowance can range from 200:1 to 50:1.

In the U.S., margin is restricted to 50:1 maximum.

How does margin work in forex?

Brokers automatically force you to use margin when you place a trade. As you as you buy or sell a currency pair, you are using a lot less capital than the value of your pair.

If you buy 10,000 EUR/USD, you are NOT actually using $10,000. If you are at 50:1 margin, you automatically use about $200 of the capital in your account to control the position. Since each pip is worth $1, a 50 pip move will affect your account by 25%.

This is how leverage is used to magnify the profit or loss of a position. The broker will enforce a margin requirement which is the amount of capital that must be in your account in order to open the position.

Once in the position, the broker will require “maintenance margin” which is the amount of money that is required to be in your account in order to maintain or carry the position.

If your capital amount goes below the maintenance margin, they AUTOMATICALLY liquidate your position for a loss. This is the infamous margin liquidation which is also common in the Bitcoin world.

This acts as a natural stop loss and prevents you from having to owe your broker money. Brokers love margin liquidations, because this is how they generate larger profits.

Note:Leverage is one of the main reasons why newer traders lose most of their capital. It’s not the leverage that is the problem, it is the misuse, abuse and ignorance that lead to unnecessary losses.

The gambling mentality, reactive trading and lack of discipline is why most forex brokers bet AGAINST their customers, and leverage helps customers lose faster. Although leverage serves the broker’s agenda, it can be a valuable asset if used responsibly.

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