Example of Leverage Loss In Forex Trading Practices.
The use of leverage is said to have two blades. It could be profitable trader but can also harm the trader. Here is an example of loss of use of leverage in forex trading practice.
Example: Sell USD / Buy JPY. Trading amount = 200,000 USD
Such as you give your attention to the Japanese yen (JPY), which trades at position 85 against US dollar (USD / JPY = 85). You expect the JPY to strengthen against the USD, so you start a sell position of USD / buy JPY in the amount of 200,000 USD. You have 7,000 USD as a margin in your account. The maximum amount you can exchange (based on 1:50 leverage) is 350,000 USD.
Leverage: Your leverage ratio for this trade is 28.57 (200,000 USD / 7,000 USD).
Pip Value: Yen Quotes are two numbers after decimal, so each pip in this trade is worth 1% of the base currency amount expressed in the currency quotation, or 2,000 yen.
Stop-loss: You set a stop loss on this trade at level 87 JPY against USD, because the yen is stable enough and you do not want your position to be stopped by random fluctuations.
Remember, you do buy JPY and sell USD, so ideally you want the yen to be appreciated versus USD, which means you can close your sell USD position with a smaller yen and pocket the difference. But if your stop loss is triggered, your losses will be great: 200 pips x 2,000 yen per pip = 400,000 JPY / 87 = 4,597.70 USD.
Profit / Loss: Unfortunately, the report of a new stimulus package unveiled by the Japanese government causes a weaker yen, and your stop-loss is triggered a day after you trade buy JPY. Your disadvantage in this case is 4.597.70 USD as described earlier.
Forex Mathematics: In conventional terms, mathematics looks like this:
Opening position: Sell USD 200.000 @ 1 USD = 85 jpy, i.e. + 17 million jpy
Closing position: Triggering stop-loss result in USD 200,000 sell position @ 1 USD = 87 JPY, ie 17.4 million JPY
The difference of 400,000 JPY is your net loss, which at a rate of 87, yielded 4.597.70 USD.
Leverage Effect: In this case, using leverage increases your losses, which amounts to about 65.7% of your total margin of 7,000 USD.
What if you only sell 7,000 USD versus yen (@ 1 USD = 85 JPY) without using leverage? A smaller amount of this transaction means that each pip is only worth 70 JPY. Stop-loss triggered on 87 will result in a loss of 14,000 JPY (200 pips x 70 JPY per pip). Using leverage then magnifies your losses by exactly 28.57 times (400,000 JPY / 14,000 JPY), or the amount of leverage used in trading.