Question

Hi Anna, I wanted to post this question up on the Q&A on your website but it doesn’t allow image uploads so I thought I would email again. I’ve been re reading your forex for beginners book and I am probably overlooking something obvious but I am struggling to understand exactly how much I am trading. My balance is the deposit I put in. The equity is the deposit and any open positions. Now in the image I have placed an order with 0.01 of a lot. I think I have wrongly assumed this was 1% of my total balance. I.e £30.05. The leverage I am using is 1:1. What I think now is that I am actually trading a micro lot worth £1000 on this trade. In your book you recommend trading 1% at a time. Say I used no leverage, using 1% (£30) at a time I would be making very little money on each trade. Am I correct in thinking in the below image I have actually traded £1000 on the open order, and not 1% but 30%!? One more quick thing if you don’t mind, Is the margin 10% in the image example of my deposit. I have been struggling with this for the past few days and am trying to figure out how much the below order would have to be in the negative before I ran out of margin? (Assuming there was no stop loss) I just can’t figure it out. I have been on multiple forums and watched countless videos It probably sounds silly and I realize I am probably overlooking something small. Any insight?

Answer

Hi – Many thanks for your email and sending such an interesting question which does in fact raise several issues simultaneously. So let me try to explain these one by one as there are two broad problems. The first is understanding the details of the account and how the various elements change once you have a live position. The second is the deeper issue concerning leverage and risk, which are very different. So let me start with the second issue first. The 1% rule that I recommend for traders has nothing whatsoever to do with leverage, which is entirely different. The 1% applies to the amount of capital you are willing to risk either on one or one multiple trades.

For example, and taking your own trading account which I believe is in sterling, here you have £3000 so your maximum risk on any position(s) should be no more than £30, ie 1% of £3k. What this means in effect is that you can be wrong 100 times on the trot before all your trading capital has gone. This lies at the heart of keeping trading losses small, and the reason is very simple. If you lose 10% of your trading capital you have to achieve an 11.1% return to recoup this loss. If you lose 50% of your capital you need to achieve a 100% return. In other words, the greater your percentage loss then the harder it becomes to recover and return to the starting point. This is why the 1% rule is so critical, although this can be increased to a higher level at the beginning, but I never suggest going beyond 5%. This level of trading risk quantified in sterling is then converted into the real market through the positioning of your stop loss. To use the above example again, if your risk is £30 and you were trading a contract where £1 equalled 1 pip then your stop loss position should be no more than 30 pips from your entry. This then maintains your rule of a 1% loss on any position as part of your total trading capital, and I hope this clarifies this for you.

The above has nothing to do with leverage, which is entirely different. You can think of leverage in terms of a mortgage or loan from your broker who is lending you money to increase your percentage return. The greater the leverage then the greater the percentage return, but equally the greater the potential loss, which is why leverage is a double edge sword. So if you are trading using a leverage of 1:100 for every dollar, your broker puts up 100. Now let me move to your screenshot and explain the various elements and what is it revealing.

First, the balance is the physical cash amount in your account and banked, and this only changes once any open position(s) are closed, for either a profit or loss. Your equity is showing what the balance would be if you closed at this precise moment. In other words it is the sum of the balance plus or minus any profit or loss. In this case your open position has generated a profit of 1.30 and if this is added to your balance this is then your total current equity. However, I do notice there a very tiny discrepancy which may be due to waiting for figures to update.

Next come margin and free margin, the first is the margin that you have used to support the current open position and the second is free margin that you have now available should you decide to open further position(s). If you add these two figures together they total the equity. And just like your equity these numbers will be update constantly as your position(s) move in and out of profit. In the current scenario if you were to open another position you would be limited to a maximum of 1677.79 as margin available to cover this position.

Last we come to the margin level figure, which is simply the equity divided by margin used and then multiplied by 100. The reason it is expressed as a percentage is that it is a much easier number to read as you approach the danger levels of a possible margin call. Moving to the current open position, and here we can see that you have a sell order on the EURGBP in the market which is currently 7.8 pips in profit, and on the right hand side we can see it equates to 1.30 which translates to approximately 0.15p per pip. This is as we would expect for the EURGBP since the sell order is specified as 0.01, which is a micro lot. In other words, a contract size of 1000 rather than 10,000, which is a micro lot. I won’t do the maths here as they are a little complicated, but you can find an explanation in my Forex for Beginners book, which also explains why the pip value varies between majors and cross pairs, as you then dealing with currency exchange in converting your pip values into dollars or british pounds.

However, in rough terms a EURGBP contract on a mini lot size equates to approximately $1.50 per pip, as opposed to $1 per pip on a EURUSD contract. What is interesting in this example, and just to confirm for you, yes you are indeed trading a micro lot at a leverage of 1:1 and you can see this from the margin since you have put up 1329.31 to support one micro lot contract, but if you were trading on leverage any margin requirement to support such a small contract would be tiny. This is the appeal of leverage as you are using other people’s money. Here you are actually using your own money, and as you can see from my explanation above, all you have remaining is a further 1677.70 to support further orders. In which case you would be restricted to only one further micro lot given your current balance and equity. Any more would take you over the threshold of the margin required to support the position. The above, of course, then translates into the whole business of returns and the advantage and disadvantage of using leverage. In fact if you consider leverage simply as ‘other people’s money’ and in much the same way as it is used in the property market, it is a great way to generate excellent returns which would not be possible using your own money. I hope this helps to clarify these issues for you and thank you sending in such interesting question.

By Anna Coulling