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Chapter 34, Part I. A Bit More About Leverage. Page 3

Discussion in 'Complete Trading Education- Forex Military School' started by Sive Morten, Dec 28, 2013.

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  1. Sive Morten

    Sive Morten Special Consultant to the FPA

    Aug 28, 2009
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    Leverage and margin definition

    Once we’ve specified it already, I would like to reinforce it, since this is extremely important. Please, go on.

    Me? All right. In the Ancient World Archimedes said that he could lift the Earth by leverage if you can give him a long enough lever and a fulcrum to place it on. So, it tells us that with just a small physical effort, leverage lets you move much greater objects. This is physical leverage. Since we are discussing money leverage, we have to replace word “physical effort” with “money”. Then it turns that we can control large amount of money with small one. For example 1:100 leverage allows us control 100 K USD with just 1000 USD. That’s why it is called 1:100. Or, with 5000 USD we can control the same 100K USD, if we have leverage 1:20.

    Commander in Pips: And how does this usually happen, that you can control 100 K with just 1 K USD?

    Well this is a broker’s service. It demands you to provide 1K, while allows you to borrow the other 99K. So, let’s say we have 1:100 leverage and control 100,000 USD with just 1000 USD. If our assets will increase to 101 K and we earn 1000 USD more we will get 100% outstanding return on our capital, since money that we’ve provided for trading is just the same 1000 USD. Hence 1000 of profit/1000 of initial assets x 100% = 100% gain. If we have 1:1 leverage, or trade with our money only, and everything else is the same we will have just 1K/100 K x100% = 1%. But what is the other side of leverage? IF you assume reducing of your position instead of increasing with the same 1000 USD you will get -100% or total loss of all assets with 1:100 leverage, or just -1% loss if you use no leverage. That is the second edge of the leverage sword. The pity is that many traders don’t fathom the idea that this sword cuts equally well from one side to the other.

    Commander in Pips: Very good. And what can you tell us about the margin?
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