In our last lesson we looked at how to determine how much leverage you are using when trading currency pairs in which the US Dollar is the base currency in the pair. In today's lesson we are going to continue our free forex trading course with a look at how to determine how much leverage you are using when the US Dollar is not the base currency in the pair.
As we have learned in previous lessons, in this particular demo account we are trading a contract size of 100,000 of the base currency in the pair. When the US Dollar is the base currency in the pair thats $100,000 per contract which, as our accounts are based in US Dollars, makes the leverage calculation fairly easy.
When the base currency is not the US Dollar however the computation for the amount of leverage employed becomes a bit more difficult, as in these cases we are trading 100,000 of of that currency, not the US Dollar. In short, what this means is that to get the amount of leverage utilized in these cases we must convert the trade size into US Dollars, and then divide that by the equity in our account.
To help illustrate this concept lets look at a couple of examples. Lets say I am trading 2 contracts of EUR/USD with an account balance of $100,000. As we have learned in previous lessons 2 contracts of EUR/USD is 200,000 Euros against the equivalent amount of US Dollars.
As we also learned, the rate in the dealing rates window for the EUR/USD or any other currency pair for that matter, is how much of the second currency in the pair it takes to buy 1 of the first currency. As of this lesson EUR/USD is trading at 1.5976 so 1 Euro is worth $1.5976. As we are trading 200,000 Euros we multiply 1.5976 times our 200,000 Euro position size to get our position size in dollars which equals $319,520.
Now that we know our position size in US Dollars, to get the amount of leverage utilized on this trade, we simply divide $319,520 by our $100,000 account balance, which gives us a leverage ratio of 3.20 to 1.
The process to calculate the leverage employed for currency pairs which do not include the US Dollar at all is the same, but be sure to use the rate for the base currency and the US Dollar to calculate the position size in US Dollars.
As an example here if was trading 1 contract of EUR/JPY then I am trading 100,000 Euros against the equivalent amount of Japanese Yen. As our account is in US Dollars we need to calculate how large a position this is in US Dollars, so we don't really care about the Japanese Yen in this situation. With this in mind we simply take the rate of the Euro US Dollar currency pair, which as of this lesson is $1.5976, and multiplying this by our position size of 100,000 Euros. We then take the result of this calculation ($159,760) and divide it by our account balance of $100,000, which gives us a leverage ratio of 1.60 to 1.
To help make this process easier I have created a spreadsheet which you can find attached to this lesson if you are watching on InformedTrades.com. If you are watching on YouTube I have included a link to this lesson in the description section to the right of this video.
For the homework assignment tonight I encourage you to calculate the leverage utilized on several trades in currency pairs which do not include the US Dollar in the pair, and feel free to post your results in the comments section of this lesson.
Thats our lesson for today, in our next lesson we will look at the different order types available in the forex market so we hope to see you in that lesson.
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Risk Disclosure: Trading forex on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial advisor if you have any doubts.