a) When we are trading using the Money Manager to calculate the size of our trades, we have the lots sizes assigned as a percentage of the Free Margin in the account. If the leverage is too high, the size of lots would go up too.
When we figured out the best amounts to trade in our default settings, we used 100:1. We made sure that even if you have orders opened for all pairs, you would never get into an over-trading situation that could trigger a margin call.
We have tested this percentages and found that they work fine, never a margin call.
But if you push up the leverage, the lots will be increased with the extra available margin, and you could find yourself over-trading to dangerous levels.
b) When we have losses, our capital is decreased. If you trade with small leverage, your losses will be small. But watch what happens with increased leverage:
Let's say that you have an account of $1000, for example, and you are using the recommended 50:1 leverage (maximum legally allowed in the US, and for good reason).
Let's also assume for this example that 1 pip= $1 in the size lots you are trading on the $1000 account (keep the figures simple).
Imagine that on a bad week you lose 100 pips. Given your lot sizes you would have lost $50 using 50:1 leverage (5% drawdown is normal for us).
But if you had been trading at 500:1, you would have lost $500 because your lots would have been that much larger. Now instead of a 5% drawdown, you now have a 50% drawdown on the account!
To get back to your starting point you now have to make $500 profit instead of just $50.
Now let's say that the next week is a really good week. BUT, your account is now only $500, which means that your trade sizes are going to be half the size of the trades you took in the losing week, (because the MM will always calculate on available margin).
To get back to your starting point you now have to make twice the number of pips to make up the loss, because each pip at half-size lots will only pay you $0.50 (whereas your losing pips cost you $1.00).
To recap, in one losing week you lost 100 pips and the next week you won 100 pips. If your leverage is 50:1, you are pretty much even because the size of your trades is more or less the same, since you only have a 5% drawdown. If you are trading 500:1, your lots will be half-size and with 100 pips you will only make up about $250, to keep figures simple, because the size of your wins were much smaller than the size of your losses. You lost 100 pips, then you recovered the 100 pips, but you still have a $250 loss to make up! You still have a 25% drawdown, even though you made up the pips!
That is the difference.
Basically, in Forex the main concern in not how fast you make your profits, but rather how much you can control your drawdown, so the size of your trades remains more or less the same, or hopefully grow at an even pace
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