RISK OF EXCESSIVE LEVERAGE
RISK OF EXCESSIVE LEVERAGE Leverage is a double-edged sword. While it has the potential to magnify a trader ’s gains, it certainly has the potential to magnify losses as well. In fact, the greater the leverage, the greater the risk. Let ’s take a look at an example. Both Trader A and Trader B open an account with a broker and start trading with a capital of USD10,000. Trader A uses leverage of 50:1 while Trader B uses leverage of 10:1. Both traders then decide to sell EUR/USD because the ongoing sovereign debt crisis is putting some pressure on the euro. Trader A ’s total contract size is 100 × $10,000 = 1 million. This equals to 10 standard lots. Trader B ’s total contract size is 10 × $10,000 = $100,000. This equals to 1 standard lot. For EUR/USD, we learned that 1 pip equals USD10 for one standard lot. If the trade goes against them by 50 pips, both traders will incur these losses: Trader A: ( 5 lots ) × ( 50 pips ) × ( $ 10 / pip ) = USD2,500 Trader B: ( 1