Dirk D. du Toit, author of "Bird
Watching in Lion Country: Retail Forex Trading Explained",
revised and increased to 340 pages, explains that
leverage should NOT be seen as something that
BROKERS ALLOW you to use, but what
YOU DECIDE to use. Understanding
the foreign exchange market can be complicated; it requires
the right tools. Dirk's book will definitely help you find and use them
"Here are a few facts:
Personally I have not seen one wiped out trading account
that wasn’t leveraged too high.
I have also no record of any sustained profitable trading
account based on high leveraged, short-stop trading.
I ask my mentoring clients early on what they believe are
the reasons for previous losses. Most answers include something to do with
leverage, not understanding it at all, or only partially, or underestimating
it once they have understood it.
Leverage then, is …?
I get many questions, like the ones below:
"I'm reading your book and I'm really enjoying
it. Can you provide me with the information where I can get 1:1 leverage
with the company you mention on page 108 of your book?"
"I'm using a demo with
only $1500 in the account with 200:1 leverage and I'm a bit worried about
this even on 1 mini contract with one currency."
"I contacted the broker you suggested where I
could trade with less than $10,000 with low leverage, but they only offer
50:1 leverage and not 3:1 like you suggest."
It is very clear that leverage is misunderstood and this
misunderstanding is a root cause of forex trading losses and the futile
attempts to overcome these losses without addressing the root cause.
Regulatory warnings that leverage is a double-edged sword
that can work for or against you go completely unheeded, just as the warning
“past performance is no indication of future performance” is flatly ignored.
Leverage is largely misunderstood because the marketing
wizards of forex (your friendly forex broker) have done a slight-of-hand
trick that shifted the focus from the very important fact of how much the
trader levers his trading capital to how much the forex marketing wizard is
prepared to lend the trader.
Everything you read about leverage has to do with the
maximum leverage you can achieve and very little about the prudent
application of leverage in a forex trading system. In other words, the
broker is telling you how much he will allow you to leverage, if you want
to, not how much you should leverage, if you know better.
Warren Buffet said – “Risk is not knowing what you are
People speak about 100:1 leverage – “I trade with
100:1”, without knowing what it means. I will show below how you are
your greatest enemy by being ignorant about this vital concept. I hope many
of you will get a very important “AHA” experience from the
A dictionary definition of leverage is:
The 'mechanical power or advantage gained through using a
A definition found at www.investorwords.com says
The degree to which an investor or business is
utilizing borrowed money.
Closer to forex trading: www.thefreedictionary.com
The use of credit or borrowed funds to improve one's
speculative capacity and increase the rate of return from an investment, as
in buying securities on margin.
Enter the concept of “margin”. Let’s make sure we
understand what margin is:
Definition of margin
The amount of collateral a customer deposits with a
broker when borrowing from the broker to buy securities.
This is exactly what you do if you open a forex trading
account. You deposit collateral in order to be able to borrow currencies to
trade currencies. Actually you don’t have to borrow, but you can if you want
The moment that borrowing comes into play it is common
knowledge that the amount that the lender will be prepared to lend has
certain limitations. Obviously you can’t lend indefinite amounts.
The thing that stumps most traders is the fact that the
marketing wizards use the terms “leverage” and “margin” very loosely and
interchangeably. This causes a lot of confusion. I
believe this is done deliberately because it is in the forex broker’s
interest that traders do not see high leverage as a destructive problem but
as an opportunity.
Let’s make sure we understand first “leverage” and then
To understand leverage properly for trading purposes,
let’s use a well-known concept. You want to buy a house, you don’t have the
capital available, but you have a salary and can pay installments on a
regular basis, so you go to the bank and borrow money to pay for the house. So you are leveraging your income / salary.
There are limitations based on, amongst others, your income which means the
amount you can borrow based on your income will be limited. There is a
maximum you can borrow. Obvious, yes, but a very important concept for the
lender – the maximum he should lend you in order to get the maximum return
on his capital without overexposing himself to risk of default on your side.
(Just a thought from the sideline. If trading forex is
mostly with borrowed funds why don’t the brokers ask interest? Think about
that …. )
Remember this: The lender is focused on maximums whereas
the borrower should be concerned with minimums - borrowing as little as he
can but still getting bang for his buck.
Now we turn to your trading account: you want to increase
your speculative capacity by leveraging your investment, therefore you
borrow money to trade with from your broker.
Before your broker will lend you money you have to put
down margin, which you wish to lever. Your broker, being a prudent
businessman has calculated his risk beforehand and is quick to tell you what
the maximum is he will allow you to borrow from him. In forex it is
typically one hundred times your capital but it can also be two hundred
times your capital or even four hundred times your capital. This is one part
of the equation:
“Dear valued customer, you will be able to leverage
your money 100:1, (200:1, 400;1). We hope we can have a long and mutually
The other side of the equation is how much of this
available borrowing you want to utilize in your speculative endeavours.
How much leverage you apply is your own decision – not something the broker can force on you.
Here is proof:
We are going to start with a stock market example.
You open a trading account with a stockbroker, with say,
$10,000. You can buy stocks to the value of $10,000. Let’s say you did.
Did you leverage your funds?
No. You didn’t borrow a cent from the broker. You have
$10,000 and the value of your stocks when you purchased them was $10,000
(ignore costs for the moment).
How do you calculate your leverage?
You divide your capital into the value of your
transaction and express it as a ratio of “value of transaction” : “capital”.
In the above example you divide $10,000 / $10,000 = 1:1
Well, your friendly online stockbroker one day sends you a
message that they now allow margined trading and you can borrow funds
to purchase stock up to the value of your current stocks. For simplicity
sake we say the value of your stocks is still $10,000. In other words you
can now buy another $10,000 worth of stocks while your capital input remains
You do this after you just received a hot tip and now you
have a transaction value of 2 X $10,000 = $20,000 divided by your capital
of $10,000 = leverage of 2:1. Or you can choose not to, it depends on
Vital for the broker: Maximum leverage allowed
The maximum leverage you can apply (as opposed to how much
you want to apply) is your broker’s decision:
The important thing you have to note in the above example
is that you have utilized all the leverage you were allowed by the
broker. This is vital. The broker takes a huge risk to lend you money
and therefore they have certain rules which you must adhere to. There is a
limit to what you can borrow from them. In the above example the limit is
leverage of 2:1 or seen from another viewpoint margin of 50%. You must
have at least half the value of your total transaction available in margin
(in other words collateral in case you aren’t as hot a trader as you
Margin is usually expressed as a percentage, while
leverage is expressed as a ratio.
The marketing wizards of forex realized that the fact that
they can offer very high leverage will be to their advantage to lure online
investors from the traditional markets. Furthermore, many online investors’
portfolios where devastated by the 2000 crash and losses of up to 90% of
formerly lucrative stock portfolios became commonplace – much of this
leveraged through stock option schemes.
As a result they started to tout from the rooftops that
leverage of 100:1, 200:1, and with the introduction of mini accounts, even
400:1 and 500:1 was available.
Terms like “trade with 100:1” leverage became the order
of the day.
An unsuspecting and clueless online trading public
swallowed this hook, line and sinker and were trading with “100:1 and 200:1
leverage”, not understanding what they are doing.
In reality the broker simply said “we will allow you
to lever your margin up to 100:1, 200:1 or 400:1 at the absolute maximum, if
you utilized all your borrowing power with us.”
But you must remember leverage is a double-edged sword. It
can work for you and against you. And so a race started amongst the forex
losers out there: where were the highest leverage, lowest margin and
narrowest spreads being offered? As if this lethal combination would
contribute to success...
So if you go to your friendly broker who offers both 100K
lots and 10K mini lots you will find that on 100K lots you usually have a
maximum of 100:1 leverage and on mini accounts 200:1 or 400:1.
So that is from the angle of the forex broker: They
will allow maximum leverage of 100:1, 200:1, 400:1.
Vital for the trader: Minimum leverage needed
How does leverage look from your (the trader’s) side?
The question from your side is: How much margin do I need
to trade a transaction of a certain value? The answer is simple, if they
offer that I can lever my funds 100 times, then it is 1 / 100 = 1%, 1 /200 =
0.5%, 1/ 400 = 0.25%.
If we return to the stock market example the question of
minimum leverage doesn’t play a role because if you have limited funds it
would be prudent to buy low priced stocks in order to be able to invest in a
basket of stocks.
But in the forex market where the minimum transaction
values were initially 100K or 10K and a shell-shocked online trading public
were lured to utilize the “advantages” of the high leverage with accounts of
just $2,000 - $3,000 or mini accounts of $200 - $300, the minimum leverage
certainly played a role.
To make all of this stick better I am going to use a real
A few years ago a now defunct tip service company did a
survey on the typical forex trading account trading with 100K lots. The
average sized account was an account of $6,000.
There is no question that the average trader will have to
borrow money from the broker, ie leverage his funds. The question is “how
much”? To do a minimum transaction of 100,000 you
divide the 100,000 by 6,000 and there is the answer: 100,000 / 6,000 =
In other words, he must borrow 16.67 times his money to do
a minimum transaction and thus utilize a minimum leverage of 16.67:1.
Just to do one silly trade.
Trading successfully: Know your real leverage
I am not going to be too technical about the exact
leverage in these examples.
In reality if you have a US dollar account you should
express the transaction value in US dollars before you calculate the exact
leverage. So if you trade 100,000 GBPUSD, you actually trade dollars to the
value of £100,000 which is at time of writing about $190,000. There is a
big difference between $100,000 and $190,000. (As Warren Buffet said:
Risk is not knowing what you are doing …)
With the flexibility offered by mini lots (10K), micro
lots (1K) and variable lots (any size the trader defines) it is easier these
days to determine one’s real leverage because you operate within the
extremes of minimum leverage and maximum leverage.
Let’s return to the questions above:
Can you provide me with the information where I can
get 1:1 leverage with the company you mention on page 108 of your book? I'm
using a demo with only $1500 in the account with 200:1 leverage and I'm a
bit worried about this even on 1 mini contract with one currency.
“Can you provide me with the information where I can
get 1:1 leverage?”
Considering that leverage is transaction value divided by
capital the important aspect is your capital and the minimum position size
because to be in a position to trade 1:1 you must have at least the same
capital as the minimum transaction. In your case you will have to trade with
a broker that offers variable lots or micro lots not larger than 1,500
“I'm using a demo with only $1500 in the account with
You refer here to the maximum leverage or the maximum
amount they will allow you to borrow. This is a fixed amount (percentage)
applicable to all transactions and it does not affect your transactions at
all, as long as you stay within this limit.
“I'm a bit worried about this even on 1 mini contract
with one currency.”
First of all there is no need to worry about the “200;1
leverage”. It simply means it is the maximum you are allowed to trade, not
what you are forced to trade (it’s your choice!). To trade the maximum would
really be silly. Your real leverage if you trade one mini contract with
$1,500 will be in the region of 6:1 or 7:1. (10,000 / 1,500).
It is interesting that you mention one currency also,
because you must know that if you simultaneously trade 2 or 3 currencies
your leverage increases. Say you trade one mini lot EURUSD, GBPUSD and
USDCHF, the total value of units = 30,000 (3 mini lots) and your capital is
Your leverage is thus 30,000 / 1,500 = 20:1. That’s
high. You borrow 20 times what you have.
To trade forex profitably you need a $3.00
calculator – not $300.00 a month charting service.
Here is the proof:
Let’s talk about the 200:1 “leverage”.
I hope by now you understand that this refers to the
maximum the marketing wizard will allow you to borrow and that you can
borrow much less to keep your leverage sane and your account afloat. But if
you go to that extreme you must be really desperate or stupid and for all
practical purposes you are already on the way out.
So what the forex marketing wizards call “leverage” is
actually the margin requirement expressed as a ratio instead of as a
percentage, which makes more sense and has absolutely no impact on your
trading, unless you are already basically wiped out or about to be.
Let’s say a trader has $10,000 and trades at a broker
which offers “flexible leverage”.
You can choose your “leverage”, 400:1, 200:1, 100:1 or
50:1. What they mean is you can choose your margin requirement (which will
define the maximum you can borrow from them) to be 0.25%, 0.5%, 1% or 2% of
the transaction value.
A trader decides to buy 5 mini lots EUR/USD, ie €50,000
transaction value and the value of one pip on this transaction is $5.00.
Let’s say he makes 100 pips profit which is $500 or 5% of his capital.
Does the flexible margin requirement, generally called
“leverage” affect this outcome?
The answer is “no”.
Leverage = 400:1 = 0.25% = $25 X 5 = $125. After 100 pips
move the Trader makes $500.
Leverage = 200:1 = 0.50% = $50 X 5 = $250. After 100 pips
move the Trader makes $500.
Leverage = 100:1 = 1.00% = $100 X 5 = $500. After 100
pips move the Trader makes $500.
Leverage = 50:1 = 2.00% = $200 X 5 = $1000. After 100
pips move the Trader makes $500.
It is vitally important that you grasp this:
The only variable in this whole trading exercise is the
real leverage, not the margin requirement.
In the example above the market moved 100 pips
irrespective of the margin required.
The only differentiating factor is how much the trader
borrows out of what is available. Depending on how
much trader borrows he will have a different outcome.
In the example he borrowed 5 times his capital, was
levered 5:1 and made $500.00. If he borrowed ten times his capital and was
levered 10:1, he would have made on the same market move $1,000 or 10% of
his capital. If he borrowed two times his capital 2:1, 2% and so on.
Margin – Leverage - Risk
People incorrectly think the risk they take has to do
with the margin requirement, forex marketing wizard’s “leverage”.
How many times have you come across money management or
risk management systems that say you must not risk
more than x% of your capital on a trade?
Let’s say our Trader used this technique and he doesn’t
“risk more than 10% of his capital” on a trade.
In the example above in the case of 2% margin (50:1
“leverage”) the Trader “uses” 10% of his capital (as margin). (Hopefully you
now realize that in reality he risks his capital 10 times!)
So if the approach is that the risk is determined in terms
of the margin that is being “put up” on a per trade basis the following
applies: Out with the calculators!
Trader has $10,000 and is prepared to "risk 10%"
Leverage = 400:1 = 0.25% 10 / .25 = 40. That is, 10%
“risk” will be 40 lots or 400K. Real leverage = 400 / 10,000 = 40:1. Pip
value = $40.00.
Leverage = 200:1 = 0.50% 10 / .50 = 20. That is, 10%
“risk” will be 20 lots or 200K. Real leverage = 200 / 10,000 = 20:1. Pip
value = $20.00
Leverage = 100:1 = 1.00% 10 / 1.00 = 10. That is, 10%
“risk” will be 10 lots or 100K. Real leverage = 100 / 10,000 = 10:1. Pip
value = $10.00
Leverage = 50:1 = 2.00% 10 / 2.00 = 5. That is, 10%
“risk” will be 5 lots or 50K. Real leverage = 50 / 10,000 = 5:1. Pip value =
This same risk management strategy then usually says,
don’t risk more than x% of your capital in potential losses, therefore
calculate your stop-loss point beforehand as a percentage of capital. So a
stop-loss is typically set at 2% or 3% of capital.
In this case, if 2%, the maximum loss value will be $200
(2% of capital of $10,000). But as you have seen now, the first part
incorrectly calculates pip value based on a bogus principle (for the
leveraged trader), while the trader supposedly “risks” 10% of his capital in
all four cases.
Leverage = 400:1, Pip value = $40.00, “risk 10%”. The
stop-loss of 2% must be 5 pips.
Leverage = 200:1, Pip value = $20.00, “risk 10%”. The
stop-loss of 2% must be 10 pips.
Leverage = 100:1, Pip value = $10.00, “risk 10%”. The
stop-loss of 2% must be 20 pips.
Leverage = 50:1, Pip value = $5.00, “risk 10%”. The
stop-loss of 2% must be 40 pips.
The above clearly demonstrates that a misunderstanding of
leverage can be devastating to your chances of success.
It also demonstrates that many so-called money management
systems are absolutely bogus - spreadsheet theory - and have nothing to do
with real profitable trading.
Suffice it to say that while the “400:1 and 200:1” options
aren’t utilized that much you will be tempted by the 100:1 and 50:1 options
as suggested by almost all the experts out there, accompanied by the
necessary 20, 30 and 40 pip stops that are hit all the time (followed by the
inevitable market movement in your initial anticipated direction).
What is usually referred to as leverage is actually the
margin required expressed as a ratio if you use all the borrowing power the
broker will allow.
Real leverage is determined by dividing your capital into
the value of your positions.
Real leverage can differ from trade to trade and
increases with multiple simultaneous trades.
Margin required has no influence on your risk if you
trade properly with modest leverage within your means and is not to be used
as a risk calculating principle.
– from Dirk D. du Toit"
You will find the same "tell it like it is" approach in
Dirk's book too. It
has helped (and continues to help) countless traders to get to grips with the hard realities of forex
trading for profit. It will show you how the "market movers" (major banks
and financial institutions that actually influence currency prices) think
and trade. If you try to go up against them, you will become "lion
fodder". The big boys always take heed of the "messages" the market is
giving them. To be successful, you need to do that too.
"Bird Watching in Lion Country" will teach
Dirk's website to order and download your copy of