When we first fire up our demos, we are excited and salivating from the visions in our minds of cruising around in our new BMWs. We push a few buttons, and we're hooked. I can recall my first experience on a Forex demo. I put on a few trades in the first half hour and made a whopping $300 profit. Not too shabby, I thought. I left a trade open and closed the platform to go about my usual business. By next morning, as I was opening the trading platform I was in awe of what my eyes were seeing – a whopping $1,700 profit on a $2000 initial balance within 24 hours. That's when I realized that this was going to be like taking candy from a baby. Of course, we all know what happened shortly there after. I opened up a live account and lost all my money within the same 24 hour period. So what exactly happened? Here's what happened: I got lucky (on the demo that is).
Let's look at my example to figure out what happens to many traders that are lacking a robust comprehension of how leverage really works. As you may have guessed, I was using standard 100K lots on my demo account. So my first $300 profit was worth approximately 30 pips (acquired purely from luck). Leaving the open trade overnight yielded an additional 170 pips or $1,700 (again, pure luck). The problem here is that on an initial $2000 balance my sizing was overly aggressive. Granted, I didn't know the difference at the time. So when it came time to open up a live account I simply continued with the same formula. However, luck was no longer on my side and as I lost my first trade worth about $500 (or 50 pips), I began worry. Like all new traders I panicked and tried to claw my way out of the initial loss by placing orders on everything that moved. Long story short – 24 hours later I was out $2000 worth of “real money”.
Bottom line, a trader must learn to understand how leverage works. I was trading at 100:1 leverage – in other words “pure suicide”. What this means is that I was borrowing $100 worth of credit from my broker for every $1 I had in the account. It's great when you win, but an account killer when you lose, as I later found out with my real account. These days I trade with a standard 1 to 1 leverage ratio. In other words, I don't borrow… unless I have to. When I do up the leverage it typically does not exceed 10 to 1. Anything beyond 10:1 leverage and I start feeling a bit uncomfortable. Of course, if I were using 1:1 leverage on my demo I would have only yielded a $20 return, instead of a $2000 return. Not as exciting, I understand. However, I would have also had $1,980 left in my real account instead of blowing it all out in a 24 hour period. The choice is yours.
