Effective Leverage

The calculation

Total notional exposure divided by equity. Equity 5,000, exposure 25,000: effective leverage 1:5. The reciprocal tells you how far the market must move against everything at once to lose the whole account: at 1:5 it is 20 percent, which does not happen in a day in the majors; at 1:50 it is 2 percent, which happens every few weeks.

A ceiling that fits

Leverage and stop distance

Effective leverage and stop distance together set the risk per trade. A 1:10 account with a 50-pip stop on a single position risks about 5 percent of equity on that trade if the pair is around parity, because 50 pips is 0.5 percent of the position and the position is ten times the equity. To hold risk per trade at 1 percent with a 50-pip stop, the position must be twice equity, effective leverage 1:2 for that trade. This is the link between the leverage number and the sizing lesson that follows.

A rule

Decide a maximum effective leverage for the whole account, perhaps 1:5 for a beginner, and check it before every new trade by adding the new position to the exposure. If it would exceed the ceiling, the trade is too large or another position must close. The margin calculator on this site shows the exposure a lot size creates.

Key takeaways

• Effective leverage is exposure over equity; its reciprocal is the move that wipes you out.
• Prudent accounts run 1:5 or less; blown accounts run 1:50.
• Leverage and stop distance together set risk per trade.
• Set a ceiling and check it before every trade.