Managing leverage as a beginner
Learning objectives
Distinguish available leverage from effective leverage and calculate the second one
Explain why sizing by risk removes the need to choose a leverage figure at all
Account for correlation when judging how leveraged your account really is
How to actually use leverage
Lesson 5 of the Discover path explained what leverage is and how margin works. This lesson is about the decisions you make once you understand it, and the first one is recognising that you've been given a ceiling rather than an instruction.
Available leverage is a ceiling
Your account comes with a maximum. Depending on the instrument and the broker, that might be 1:10 on stock CFDs or many hundreds to one on major currencies.
That number describes the most you're permitted to use. It says nothing whatsoever about what you should use, and nothing about what the trade in front of you calls for. A trader on an account offering 1:1000 who opens a small position is using a fraction of a percent of what's available, and there is nothing wrong with that. That's what the ceiling is for.
The mistake isn't using leverage. It's treating the maximum as a target, or assuming that a facility being offered means it's appropriate for you.
The number nobody calculates
Available leverage is a permission. Effective leverage is what you're actually doing, and it's the number that matters.
Effective leverage = total position value ÷ account equity
Anna has $500 in her account and opens 0.10 lots of EUR/USD at 1.0850. That position is 10,000 units of euro, so the position is worth about $10,850.
$10,850 ÷ $500 = roughly 22:1
Her account might permit far more. She is using 22:1, and 22:1 is what determines what happens to her.
Now the same account with a smaller position, 0.01 lots:
$1,085 ÷ $500 = roughly 2:1
Same trader, same account, same permitted maximum. Two very different situations, and the difference has nothing to do with the leverage her broker offers.
Effective leverage is worth calculating occasionally, because it's the one honest measure of how exposed you are. Most beginners have never worked it out and would be surprised by the answer.
Why you never have to choose a leverage number
Here's the part that makes this lesson short.
If you size positions the way lesson F2.3 describes, working from a fixed risk percentage and a stop distance, leverage is handled for you. You never select it. It falls out of the calculation as a by-product.
The two approaches produce completely different behaviour:
- Sizing by leverage: "My account allows 1:500, so what's the biggest position I can take?" The answer is always too big, and your loss is whatever the market decides.
- Sizing by risk: "I'm risking 1%, my stop is 25 pips, so my position is 0.02 lots." The answer is whatever it is, your loss is capped by design, and the leverage is incidental.
Position sizing is leverage management. They aren't two disciplines. They're the same discipline, and only one of them requires you to think about leverage at all.
Margin is not the constraint
A related trap, and it's the one lesson 7 on our Market Mechanics module warned about.
Because leverage is high, margin requirements are low, so your platform will happily let you open positions far larger than any sensible risk calculation would produce. Free margin will look healthy while you do it.
Margin answers the question "can I open this?" Risk answers the question "should I?" They are different questions with different answers, and only one of them protects your account. On a high-leverage account, the margin figure will almost never be the thing that stops you. You have to stop yourself.
Correlation: where effective leverage hides
One more thing, because it catches out traders who are otherwise careful.
Suppose you're long EUR/USD, long GBP/USD and long AUD/USD, each sized at 1% risk. It looks like three separate trades at 1% each.
It isn't. All three are, substantially, the same bet: the dollar weakens. If the dollar strengthens sharply, all three lose together. Your real exposure to that single event is closer to 3% than 1%, and your effective leverage is the sum of all three positions against the same equity.
The same applies to holding several correlated indices, or gold and silver together, or a basket of shares in one sector.
So calculate effective leverage across everything open at once, not per position. And when several positions depend on the same thing being true, size them as though they were one trade, because that's how the market will treat them.
Key takeaways
Available leverage is a maximum you're permitted, not a target. Using a small fraction of it is normal and correct
Effective leverage is total position value divided by account equity. It's the number that determines your outcome
If you size positions from a fixed risk percentage and a stop distance, leverage takes care of itself. Position sizing is leverage management
Correlated positions are one bet in several costumes. Calculate effective leverage across everything open, not trade by trade