Forex and the Using The Edge Of Leverage

The definition of leverage means to apply multiplied forced to something. Leverage has the idea of a mechanical advantage of some type...such as in using a lever. "Give me a lever long enough and a fulcrum strong enough and I will move the world." Anybody remember who said that? (Of course, I believe he said it in Greek, so it wasn't exactly like that, and that is also your first clue!)

The science of leverage offers us a few good insights into successful trading. Leverage gives a man an advantage. Whereas, without it, he his limited in his capacity to move large objects, with it, he can moves things many times larger than himself. He can also control the direction the object goes if he does so with some carefulness.

In trading, we always are looking for an advantage. ALWAYS. Trading without an advantage is like rolling a heavy rock uphill. Not only is is amazingly difficult---but it is very likely to return right back down over top of you once you let it go. Most of us have had that experience in trading. If we were on video, I'd ask for a show of hands. But we have taken poor trades, against the trend, or at the end of an exhaustion, only to see the trade start our way, then roll right back over us. Dazed and confused we get up, look at the losses in our account, and scratch our heads in wonder.

Trading good set-ups, like rolling a rock down hill, is far easier. And there is very little chance that he rock will return to run back over you as well. So I repeat, we are always on the lookout for advantages: better risk to reward scenarios, good trends with an entry on a pull back to support or resistance, reliable chart patterns that offer us shorter stops.

But one advantage we always have is the use of leverage. Now in science, we usually figure that the higher the leverage, the better. After all, you can accomplish more work with higher leverage than lower. Right? But that's not what I mean in trading terms. Higher leverage is ALWAYS WORSE. IT IS ALWAYS MORE DANGEROUS. If there were some way I could imprint that on the back of your hands so that when you sit down to the keyboard to begin trading, that would be the first thing you see, I would do it. A man or woman will never allow themselves to become a good trader if they use high leverage. It may work for a time, but will eventually blow up your account. THERE IS NO WAY TO AVOID THAT.

But leverage is helpful, in that it can really assist those getting started, and those who will use it in an advantageous and judicious manner. One of our basic trading rules is that a trader should not leverage his account higher than $1/pip for every $10,000 in account. This is fairly straightforward math. A nice 50 pip move will generate $50 off of a $10,000 account. That is 1/2 of a percent. Multiplied out over a month, that is 10% return monthly. A nice 100 pip move turns into 20% monthly. Of course, we can't do that every day. Sometimes decent set ups aren't there at the times of the alert. Or we miss the trade because it has already started to move before we got to the computer. Other trades are just plain losers, so we are out 50-100 pips. So it is unwise to simply multiply what you can easily make each day over the entire month. One must allow for down and negative days as well.

But be that as it may, low leverage will keep you from blowing our your account. And it will keep you in the game while you keep learning how to make 10-20% monthly. This is entirely possible. And so are even bigger bonanzas. Just a few weeks ago, in my private trading account, I topped 30% in 5 days. That was wonderful, but it should not be my goal. I can guarantee that if I started working for that each week, I would begin to lose money. Why? Because I would quit using my advantage. I would stay in trades too long hoping for a bit more. I would enter questionable trades. I might even be tempted to move my stops to give a trade more "room". Instead, I will just take it as a gift from God, let it add to my balance, and know that a week will come, (which just happened) that I will have a losing week. And I'll need those extra profits to smooth out my profit curve.

So always remember, one of your advantages is that you can trade small. Let it keep you in the game. Let it build your skill. Because good traders are NOT born. They develop. You can develop this skill. But only through the discipline of trading low leverage. After a few years, you can increase it if you like. But keep a close eye on your balance. If it starts to deteriorate, you'll know why. Better be on your toes to change that leverage back!

Happy Trading!

Bill
www.thefxtradingmasters.com
bill@thefxtradingmasters.com