On one hand traders can exploit the maximum margin requirements that the broker-dealer provides, which can range from 100:1 to 400:1, but on the other hand we have the technical aspect of the mechanism. When asking what leverage you are using in your trading, you have to refer to the leveraged amount which you are effectively using to enhance your trading strategy.The effective leverage is of paramount importance. There is nothing wrong in choosing the maximum level of leverage that the broker-dealer allows. What can put a trader in a dangerous situation is when the effective leverage comes close to the maximum displayed by the broker-dealer.
The effective leverage is calculated by dividing the value of open positions by the available balance of the account. In other words, the real leverage is the amount of capital you are really using compared to the amount in your account.
With a position worth of $20,000 (2 mini lots) and an account balance of $1,000, the real leverage is 20:1 (20.000/1.000 = 20). If this trade loses 50 pips, the account balance would go down by 10%. Remember, the pip value would be $2,00, multiplied by 50 pips, that is $100.
Should this loss happen, the real risk would increase with the next trade - now a loss of $100 is 11% of the account. This also means that the effective leverage rises even if the position size is kept the same, because the account balance is now lower. This is the typical dynamic of a losing spiral we mentioned when traders blow up their accounts - by doing the same, they lose more with each trade. This is because leverage increases each time.
To compound the issue, if the trader increases his/her leverage deliberately thinking in recovering losses faster, he/she is not acting in his/her best interest.
A leverage of 20:1 in a single position is quite high if we are to stay in the market for the long run. If our method is efficient in terms of consistency, then we can fine tune the leverage to get the maximum profit from it. This doesn't mean to exploit the maximum leverage offered by the broker-dealer, but instead, to use the maximum leverage that our method can sustain without the danger of a margin call.
For instance, you can have 5 open positions with an effective leverage of 4:1 each one. This way, you arrive at a leverage of 20:1 by adding 5 positions, and you will be eventually better protected with multiple positions over different currencies, than betting that leveraged amount in just one currency pair. The same leverage of 20:1 spread over several positions is a measure to diversify your risk.
How to bring this into practice will be discussed further when studying the development of trading systems and money management techniques. For now let's take one more step in the appliance of the mechanics you have just learned.