Effective leverage on a $5,000 account: what 1 lot, 0.5 lot and 0.1 lot of EURUSD really are

[Fairman]

Effective leverage on a $5,000 account: what 1 lot, 0.5 lot and 0.1 lot of EURUSD really are

Account leverage like 1:30 or 1:500 is a ceiling on how little margin you can post. It says nothing about how much risk you're carrying. What you carry is notional divided by equity. EURUSD at 1.0800, account $5,000:

1.0 lot is $108,000 of notional, so 21.6 times equity.
0.5 lot is $54,000, so 10.8 times.
0.1 lot is $10,800, so 2.16 times.

At 21.6 times, a 1% move in price is a 21.6% move in equity. A 5 pip stop on that lot loses $50, which is 1%. A 100 pip move, about 0.93% of the price, loses $1,000, which is 20% of the account. For comparison, one lot of gold, which is 100 ounces, at a hypothetical $2,000 an ounce is $200,000 of notional, 40 times the same $5,000.

Two traders can both sit on 1:500 accounts and have no resemblance to each other, one at 2 times and the other at 40. The label on the account tells you nothing about which is which. The number I'd look at before clicking is lots times contract size times price, divided by equity.

[FXS HongKong Scalper]

Thinking in notional divided by equity is a clear way to see the real risk. One way to use this is to set a maximum effective leverage for the account, such as 10 times, and check it before opening each new position. That covers the case of several smaller positions that together are as large as one big one. It is also a good check when trading pairs with different pip values, since effective leverage is based on notional rather than pips.

[Fairman]

Risk based sizing puts the leverage number out of your hands. Risk 1% of $5,000, so $50, on a 5 pip stop: that's 1 lot, 21.6 times. Same $50 on a 20 pip stop gives 0.25 lots, $27,000 notional, 5.4 times. The tighter the stop, the higher the effective leverage, because the same dollars of risk are spread over fewer pips. So leverage isn't a choice made independently of the strategy. A scalper using 5 pip stops lives at high leverage whatever he intends, and the only way to bring it down is to risk less per trade.

[Amanhasnoname]

This is the calculation that finally made me stop trading full lots on a small account. A few years back I had about $4,000 and was happily taking 1 lot on EURUSD scalps with 4 pip stops, telling myself the risk was only 1%. It was, as long as the stop filled. One morning a data release gapped through it by 11 pips and I lost close to 4% on a trade I thought was tiny.

What changed was looking at it the way you describe. At roughly 27 times equity, any slippage is multiplied by the same factor, so a fill problem that would be a nuisance at 3 times becomes a real hit. I now cap myself at about 12 times effective leverage across all open positions, which in practice means I widen my stop a little and trade smaller rather than squeezing a tight stop to justify size.

The gold comparison is a good one. I did not realise how quickly a single gold trade pushes the total over any sensible ceiling until I wrote the notional down.

[Fairman]

Margin shows another view. One lot at 1.08 on a 1:30 account needs $108,000 divided by 30, which is $3,600. Margin level is equity divided by margin, so $5,000 over $3,600 is 139%. At a typical 50% stop out level, positions start closing when equity falls to $1,800. That's a loss of $3,200, or 320 pips on one lot. So the account survives 320 pips against a single full lot before the broker closes it, but only a few trades like that and the buffer is gone. The stop out level and margin call level differ between brokers, so check yours.

[Fairman]

Gross exposure adds up across pairs. Three half lot trades on $5,000: EURUSD at 1.08 is $54,000, GBPUSD at 1.27 is $63,500, and USDJPY, where the dollar is the base currency, is $50,000. Total $167,500 of notional, which is 33.5 times equity. At 1:30 the margin would be $5,583, more than the account holds, so the third trade wouldn't even open. Some of those positions may offset each other, since a long USDJPY and a long EURUSD point in opposite directions against the dollar, but the gross figure is still the one to look at when the market moves against all of them or when correlations break.

[Fairman]

A personal cap is easy to set. Choose a maximum gross leverage, say 10 times. On $5,000 that's $50,000 of notional, or 0.46 lots of EURUSD at 1.08 (50,000 divided by 108,000). Before entering, compute lots times 100,000 times price, divided by equity, for USD quoted pairs, and add the open positions. A sheet or a few lines in an EA does it. The cap may be above or below what your stop sizes imply, and where they conflict, take the smaller. A 10 times cap would make a 5 pip stop with 1% risk impossible, which says something about that setup.