Chapter 34, Part II. Overleveraging and Transaction Costs. Page 4

Again, you’re newbie day trader and you apply just a 50 pip stop-loss in most of your trades. You’ve checked it by the market’s volatility and come to the conclusion that for intraday charts this stop is sufficient. You’ve opened mini account with 1000$.


TASK #3 – you have decided that this was just a fake out and thought that maybe you have to place farther stops. So, you’ve entered with the same 4 mini lots, but with 70 pip stops. Right at this moment an ECB rate hike has happened and you have been stopped out…

Pipruit: Ok, ok -

Leverage = 4*10,000/810~50:1;

Loss = 0.0070*50*100 = 35%

Account balance now is 810-70-120-280 = 460$
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TASK #4 – you see that the market probably is returning right back and on the ECB statement that was just short covering before the announcement. You think that this probably will be easy money, based on a 5-min Butterfly, you just need to increase lot size… When you’ve thought about your trading plan, that over half your account has totally vanished and that is not good, you start to think that you have no choice – double or nothing.

Pipruit: Yes, so – I intend to enter on 5 min chart with 10 lots – stop will be tight – 20 pips, since this is 5 min chart!
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Commander in Pips: But this was not short covering….

Pipruit: Oh, no…

Leverage = 10*10,000/460 ~217:1
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Commander in Pips: Price moves down for 15 pips, then turns up and move for 70 pips in your favor.

Pipruit: Finally, I’m returning in Big business and my profit is…
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Commander in Pips: …not so fast, son. You’ve forgotten that your broker provides you with just 1:250 leverage. So, when you have opened 10 mini lots – how much free margin do you have?

Pipruit: 460 – 10*10,000/250 = 460-400 = $60.
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Commander in Pips: But, as we’ve said, the market has moved against you first for 15 pips or 150$. It has not reached your stop loss, but you have another frustrating problem – what is it?

Pipruit: Margin call… After just 6 pips against me… 6 pips!
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Commander in Pips: That’s the cost of overleveraging and underestimation of it. Also pay attention to how “trader’s sins” go side-by-side with destroying of your trading plan. First, you just entered with slightly greater lot, later you totally have broken all money management and in last trade you have absolutely denied and negated your entire trading plan per se.

Pipruit: Right, sir. But in reality I hope that I will not fall into this pit. I will try to be a disciplined and diligent trader.
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