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RichardCox

Appropriate Leverage Levels for Forex Trading

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One of the characteristics that separates new traders from experienced traders is the way each uses leverage. One reason for this is that since many starting traders recklessly abuse leverage, they lose their entire trading accounts and are not able to stay in the game long enough to actually become experienced traders. The ones that are able to use leverage responsibly are the ones that are able to construct workable trading plans that can be successfully repeated over time.

 

In fact, you can almost guess how a trader will use leverage based on the amount of money that is in a trading account. Newer traders tend to have smaller amounts of capital when starting and accounts with less than $5,000 tend to approach position sizes in aggressive ways. Since these accounts are much smaller, it becomes very easy for a few trades to go wrong and wipe out the account entirely. Traders with larger account sizes tend to be in less of a rush to make money and the result of that leverage tends to be approached in more conservative ways.

 

Protective Position Sizes

 

Many experienced traders advise newbies to apply leverage ratios of 10:1 or less (which means that at least $1 is deposited for every $10 in a position size). More experienced traders (and those with larger account sizes) tend to have successful trades in larger percentages. While this might seem to be something of a tautology, a large part of how this happens comes with effective uses of leverage that are not overly risky yet still allow for sizable gains.

 

One of the most important trading rules to remember is that excessive leverage levels can quickly magnify losses and leave new traders feeling overly emotional, as though trading is impossible or even that your broker is running a scam operation. These factors can snowball and create a dangerous cycle that can lead new traders discouraged and unwilling to continue.

 

Leverage as Part of Your Strategy

 

Another key point to remember is that recklessly using leverage can even destroy what would otherwise be a solid and successful strategy. So, using leverage effectively can have a significant and direct impact on your overall profits and losses. Since no trading strategy can prepare you for changing market conditions 100% of the time, so it must always be understood that losses can be taken on at any time. The surest way of protecting against these potential changes is to always use stop losses and to keep trading sizes at conservative levels.

 

When constructing your trading strategy it is always a good idea to keep this simple equation in mind, based on the equity in your account:

 

Total Account Equity * Preferred Leverage Ratio = Maximum Trade Position Size (for all open positions combined)

 

So, if you are trading at the upper end of the acceptable leverage range (10:1), an account with $1,000 in total equity will never allow open positions to pass $10,000. Your preferred leverage ratio however, will vary. More conservative traders will be able to use ratios of 2 or 3 to 1, or, perhaps, no leverage at all (a ratio of 1:1). More aggressive traders can still sustain their accounts with slightly higher levels.

 

Of course, leverage can be managed either by adding to your account equity or by decreasing the size of your trades. Most successful traders tend to place their focus on the amount of money that is being put at risk, rather than the potential gains of a trade. Leverage is a powerful tool that can cause one losing trade to completely erase a strong of successful trades. Keeping leverage at conservative levels can help to slow losses when they do occur and can help to protect against losing streaks. Successful traders have confidence in their methods while being sensible in their profit expectations. Successful strategies generally require a sufficient amount of trading capital of sufficient capital (trading accounts worth at least $5,000) and conservative approaches to leverage (with ratios not exceeding 10 to 1).

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It's funny how the most actively traded forex and futures financial products are very highly leveraged. The eurodollar futures contract boasts between 1:1000 - 1:5000 depending on the broker you use and their day trading margin. Non-USA/JPY retail forex brokers typically have anywhere between 1:200 to 1:1000 leverage on offer for most of their currency pairs, and their minimum lot sizes can go down to 10 units of the base currency (although 100 or 1000 units minimum is more common minimum for some accounts).

 

The leverage only is appropriate for determining how many positions per tick or per pip that the account can trade before being unable to trade anymore. This is best done mathematically using a spreadsheet designed for this purpose. This is how you can determine with 100% objectivity how much of an actual pip/tick range in market movement you can handle from initial entry before blowing up your account.

 

One person said it best on a different forum: if you cannot sleep at night with the amount of open positions you have, then you are over-leveraged. It can be a big temptation to overuse leverage, when unaware of the true power of position sizing. One advantage about using the spreadsheet is that you can determine your level of aggression and then copy the lot sizes into your system and forward test different levels to paint a clearer picture of the difference between aggression and recklessness.

 

The idea of not using more that 1:10 leverage is a rehash of the "risk no more than x% per trade" idea. Neither of these abstract-only method address the strategy being used for entries. They also do not address pip or tick value price movement relative to each (or total) position size. Luckily for most traders, price is linear and all these relevant events: pip/tick value, position size, and position value per pip/tick can be calculated precisely from entry to exit (equity stop loss or take profit). Use the spreadsheet or something similar to determine these precise values. It is true that we cannot predict the exact range of price travel all the time. So shouldn't the goal be to focus our attention almost exclusively on the aspects we have control over in the most objective manner possible?

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It's funny how the most actively traded forex and futures financial products are very highly leveraged. The eurodollar futures contract boasts between 1:1000 - 1:5000 depending on the broker you use and their day trading margin. Non-USA/JPY retail forex brokers typically have anywhere between 1:200 to 1:1000 leverage on offer for most of their currency pairs, and their minimum lot sizes can go down to 10 units of the base currency (although 100 or 1000 units minimum is more common minimum for some accounts).

 

The leverage only is appropriate for determining how many positions per tick or per pip that the account can trade before being unable to trade anymore. This is best done mathematically using a spreadsheet designed for this purpose. This is how you can determine with 100% objectivity how much of an actual pip/tick range in market movement you can handle from initial entry before blowing up your account.

 

One person said it best on a different forum: if you cannot sleep at night with the amount of open positions you have, then you are over-leveraged. It can be a big temptation to overuse leverage, when unaware of the true power of position sizing. One advantage about using the spreadsheet is that you can determine your level of aggression and then copy the lot sizes into your system and forward test different levels to paint a clearer picture of the difference between aggression and recklessness.

 

The idea of not using more that 1:10 leverage is a rehash of the "risk no more than x% per trade" idea. Neither of these abstract-only method address the strategy being used for entries. They also do not address pip or tick value price movement relative to each (or total) position size. Luckily for most traders, price is linear and all these relevant events: pip/tick value, position size, and position value per pip/tick can be calculated precisely from entry to exit (equity stop loss or take profit). Use the spreadsheet or something similar to determine these precise values. It is true that we cannot predict the exact range of price travel all the time. So shouldn't the goal be to focus our attention almost exclusively on the aspects we have control over in the most objective manner possible?

 

To further your thinking here a bit if I may... the real issue that should be addressed here is "what am i trading for.... what are my goals". If your goal is to turn $100 into $1 million in 1 year, and you have a hypothetical holy grail strategy that will provide a big enough edge to justify a massive risk amount, then in fact that is what you should be risking per trade, even if it is upwards of 30%.

 

Of course, only fools make it a "goal" to "win the lotto". And if you have such an edge that really could do this...well, you won't need that $100 anyway, you'll get rich almost regardless of any risk management approach.

 

But of coiurse you DON'T have this edge.

 

Now, say your goal is to take a 10K nest egg, and grow it to the point where you can make 50K a year with. And you determine your edge justifies taking a 2% risk per trade, and in doing so it will very likely not suffer more than a 20% drawdown, at any time in th next 10 years, and and with that risk amount you can make about 50% ROI per year... and you want to be able to go full time making that $50K within 7 years.

 

WELLLLLL... now that you actually know what you have, and what you are shooting for, and how long you are willing to give it, and how your method will likely perform over that period of time...

 

you also know what you should risk per trade. And notice how the question or issue of leverage now is actually completely irrelevent.

 

Discussing what leverage one should use on a trade is like discussing what pair of pants you should plan on wearing at your 350th birthday party. It doesn't matter, because your not gonna get to be 350, and even if you were... it has absolutly nothing to do with your goals or why you are trading, or your account, or what your system can handle or anything else.

 

Because when you start talking leverage, as in "how much is enough", you're probably already F'd.

 

I know of no professional trader who even considers leverage as a function of capital. But I know every single one of them looks at risk, reward, drawdown, percent return per year, month, week, expectancy per trade, standardard deviation of drawdown, etc.

 

Why anyone cares about leverage escapes me. It's like caring how much foam rubber they put in your seats in your car, but totally overlooking the miles on the engine, or if the car even drives....etc.

 

Personally 4Ever...I'm wondering who this richard cox guy is... he must have a ghostwriter doing this. his articles are either total fables, or highly irrelevent. I'd be willing to bet anyone $1000 bucks that no one reading this or anything else he's posted tonight will be able to do a single thing with any of it, in terms of trading.

 

Anyway, the leverage issue is age old, and frankly, my trading success or lackthereof is actually more dependent on whether my wife prepared a good dinner for me or not on any particular evening, than it EVER is on my "leverage"

 

TraderX

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I know of no professional trader who even considers leverage as a function of capital. But I know every single one of them looks at risk, reward, drawdown, percent return per year, month, week, expectancy per trade, standardard deviation of drawdown, etc.

 

Why anyone cares about leverage escapes me.

 

I know plenty of traders who do care about both their capital and how much leverage they can get out of it (I think this may just be semantics here ForexTraderX)

 

The first question that should always be asked when someone quotes their returns is - how much leverage are you using as it puts all the others into perspective.

Too often people quote "i made xxxx%" - irrelevant without knowing what that is based on, and those measures you quote help quantify that.

Be wary of those who say - 'I can make you $1mil, I just need access to $10m and for that you only need to put up $200,000"

 

Leverage is a tool to enhance or destroy returns faster or slower depending on the system.

 

To be able to properly measure things historically you need to understand both the capital base and the amount of leverage used.....

 

however in determining how much leverage to actually trade then - the "sleep well" or "heat" measure is probably the best measure their is IMHO.

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I know plenty of traders who do care about both their capital and how much leverage they can get out of it (I think this may just be semantics here ForexTraderX)

 

The first question that should always be asked when someone quotes their returns is - how much leverage are you using as it puts all the others into perspective.

Too often people quote "i made xxxx%" - irrelevant without knowing what that is based on, and those measures you quote help quantify that.

Be wary of those who say - 'I can make you $1mil, I just need access to $10m and for that you only need to put up $200,000"

 

Leverage is a tool to enhance or destroy returns faster or slower depending on the system.

 

To be able to properly measure things historically you need to understand both the capital base and the amount of leverage used.....

 

however in determining how much leverage to actually trade then - the "sleep well" or "heat" measure is probably the best measure their is IMHO.

 

Well... ok, I agree to a degree that it's primarily an argument of semantics.... (lots of those in trading it seems).... however, risk parameters and drawdown statistics cover that as well, and do a better job of it than leverage, IMO.

 

Yes, pro traders do consider leverage in a certain point of view, but on any given trade, it's really risk:reward... and since very few professional traders I know of risk more than 5% of their own equity per trade (heck, most don't even risk 2% per trade), the issue of leverage just doesn't come up, because they are never really "leveraged" more than about 10:1 or 20:1, at MOST.

 

and when it comes to institutional trading, leverage is almost a non-issue, because liquidity becomes the overriding factor... because no on will "leverage" up to the point where liquidity becomes a problem for them... and since they are trading 7, 8, or even 9 figure sums... liquidity becomes an issue long before leverage does.

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and when it comes to institutional trading, leverage is almost a non-issue, because liquidity becomes the overriding factor... because no on will "leverage" up to the point where liquidity becomes a problem for them... and since they are trading 7, 8, or even 9 figure sums... liquidity becomes an issue long before leverage does.

 

I agree that for many traders they may not take into account their leverage, but if you dont understand it then I will gurantee you one thing - your back tested, or historical worst case DD will be broken. Of course depending on what you are trying to achieve is important here, and when introducing institutions into the mix.....well, most are unleveraged, either due to mandates or regulatory or internal risk controls.

but without digressing into the insto world....

 

if a trader tells you he made XXX% or dollars, I would always ask on what leverage - because from that you can guess his other parameters....

which would you rather back

trader A.....2% risk, max historical draw down 30%, returns 50% pa, leverage 2X

trader B.....2% risk, max historical draw down 30%, returns 50% pa, leverage 10X

 

it another measure that many miss use, or neglect or think irrelevant....

Look at what happened when many leveraged themselves up circa 2007......

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I agree that for many traders they may not take into account their leverage, but if you dont understand it then I will gurantee you one thing - your back tested, or historical worst case DD will be broken. Of course depending on what you are trying to achieve is important here, and when introducing institutions into the mix.....well, most are unleveraged, either due to mandates or regulatory or internal risk controls.

but without digressing into the insto world....

 

if a trader tells you he made XXX% or dollars, I would always ask on what leverage - because from that you can guess his other parameters....

which would you rather back

trader A.....2% risk, max historical draw down 30%, returns 50% pa, leverage 2X

trader B.....2% risk, max historical draw down 30%, returns 50% pa, leverage 10X

 

it another measure that many miss use, or neglect or think irrelevant....

Look at what happened when many leveraged themselves up circa 2007......

 

I personally just don't factor in leverage at all.

 

In my trading, I have a fixed stop loss point, and my risk amount is based on a percent loss that will be incurred if i hit that stop loss point.

 

For example, I may have a trade where Ii'm risking 1% of a $10,000 account on a trade with a 100 pip stop.

 

This would be about $1.00 per pip, which is almost not leveraged at all.

 

However, I may have another trade where I'm risking 1% of a $10,000 account on a trade, with a 3 pip stop.

 

That's $33 a pip, and is obviously much more leveraged than the first example. But it doesn't matter, because 1% risk is 1% risk, and $100 potential loss is $100 potential loss.

 

if one demonstrates risk, drawdown, and profits purely in percentage of account equity, then leverage is a mute point. And for my own tradign, as well as most others I know of who trade for a living, a sharpe ratio, or a traders Beta is a far superior data point to determining what type of risk a trader is taking, than "how much is their leverage".

 

maybe it's just a matter of opinion here, or maybe i'm missing something... but I dont' see a single place that leverage amount is important to know that exposure of account equity in terms of % that can be lost or a sharpe ratio, or a beta number, won't give a better insight on.

 

If i'm wrong, please point out where.

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if one demonstrates risk, drawdown, and profits purely in percentage of account equity, then leverage is a mute point. And for my own tradign, as well as most others I know of who trade for a living, a sharpe ratio, or a traders Beta is a far superior data point to determining what type of risk a trader is taking, than "how much is their leverage".

 

maybe it's just a matter of opinion here, or maybe i'm missing something... but I dont' see a single place that leverage amount is important to know that exposure of account equity in terms of % that can be lost or a sharpe ratio, or a beta number, won't give a better insight on.

 

If i'm wrong, please point out where.

 

A: Gaps.

 

Dont worry i am not arguing with you, I am adding an extra measure that when assessing a strategy then leverage is a component.

Otherwise simplistically - why not just say the past draw downs have only been X, therefore we can leverage ourselves to this....plus for all those people who say I return 100% per month - its not generally scalable - hence why leverage is a valid component to understand....it is certainly not a mute point as many have found to their peril in the past.

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A: Gaps.

 

Dont worry i am not arguing with you, I am adding an extra measure that when assessing a strategy then leverage is a component.

Otherwise simplistically - why not just say the past draw downs have only been X, therefore we can leverage ourselves to this....plus for all those people who say I return 100% per month - its not generally scalable - hence why leverage is a valid component to understand....it is certainly not a mute point as many have found to their peril in the past.

 

Ok, i'm 100% with you on this. it is important to understand leverage on a conceptual level, and always consider total exposure (leveraged total exposure) at any given time.

 

Just speaking personally, if I risk even upwards of 2% of my account on a single trade, i never even get into 10:1 leverage... and that's regardless of whether my stop loss is 15 pips, or 100 pips.

 

I think me personallly my average trade works out to be about 5:1 - 8:1 leverage.

 

and for someone who is day trading, I believe risking even 2% per trade is pretty cowboy. Of course, there are mathematical ways of determining what the "appropriate or optimal risk" is for a trade, based on win rate, profit in terms of R, standard deviation of "average losing/winning streaks"...etc.

 

but all that being said, if one is getting just 1 trade per day, and has a 60% win rate, with winners and losers each averaging 1R... risking 2% of ones account per trade will generate approx. 8% per month. If the account is left to grow, within 5 years, a person can take $10,000 and run it up to over 1 million.

 

In another 2.5 years (7.5 years total), that $10K will now be 10 million, and so on...etc.

 

I guess what smacks me funny about the whole idea of needing to know what your leverage is, because you'll likely blow up if you don't understand it...

 

is that if a person has a $10K account, and if they are risking approx. 2% of their account, on a trade in the EUR/USD, and they have a 20 pip stop on the trade....that would leverage them up about 10:1.

 

If they have a 40 pip stop, to acheive the same risk amount on that trade, with the same account size, etc... they would only be leveraged 5:1.

 

And, considering the typical 1-2 pip spread on the EUR/USD for most spot forex traders, if someone has a "strategy" that targets 10 pips or something... they need to overcome a significant disadvantage due to just even a 1 pip spread... making most strategies used by retail traders with retail brokers absent of long term viability if they are going for small pip moves (like, anything less than 10 pips). It's just too much to overcome, due to transaction costs being such a high percentage of your profit on little 10 and 12 pip targets.

 

so, given than it's safe to assume at least a 1 pip spread on the EUR/USD for the retail trader, i would say a minimum "average" target should be about 20 pips. otherwise...the "juice" is just too high for the vast majority over the long run.

 

And now we are basically back where we started. a 20 pip target, with a 10K account, and 2% risk per trade, with a risk:reward ratio of 1:1, and a 60% win rate... you can take 10K over 10 million in about 7 years...and in doing so, you will never exceed 10:1 leverage on any single trade.

 

If this is such a paltry sum for a would be trader, and obviously nothing less than "30% profit per month will do"... then I think that trader has MUCH bigger problems than the potential to over leverage!

 

I do agree with you that it is good to understand how leverage works... and maybe i'm just an arrogant bastard, but I tend to think that if one is blind to the fact that they are greatly over leveraged, and that person has no concept or understanding of why that is bad.... I welcome them to the marketplace, and I only can hope for them to be on the other side of my trades...

 

something akin to driving a Ferrari down a freeway at 160 MPH, and not realizing why that is dangerous.... well, I got a darwin award for ya buddy.

 

ANyway, I think we've beat this horse good and dead. yes, leverage is important to understand, but if one doesn't get that almost intrinsically, instinctively, maybe this isn't the right field for them.

 

FTX

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Bear in mind that most of the brokers do not guarantee Stop Loss and Take profit. Best idea is to take leverage into consideration which leverage you use because the higher the leverage, the higher the risk.

 

Well ok that's true about the brokers, but for me, it's only been an issue maybe 4 or 5 times ever in my trading career, out of thousands of trades... and the WORST I ever had was about 15-20 pips of slippage when the SNB announced they were pegging the euro, and once when the tsunami in japan occured, I think I got about 10 pips of slippage when the news broke.

 

It's just such an incredibly insignificant issue, that if your actually having regular problems with "slippage" causing massive losses because your leverage amount was high, then it's your broker...and if it's not your broker, i'm willing to bet that on your losing trades, your account drops by well over 2% every time you lose.

 

and it's NOT true "the higher the leverage, the higher the risk". and I'll prove it here:

 

A trader has a $10,000 account. He takes a long trade on the EUR/USD with a 10 pip stop, and a 11 pip target (an extra pip to cover his 1 pip spread). He risks 2% of his account balance on this trade, so should the trade hit is stop 10 pips below, he will lose $200 (which is 2% of his 10K)

 

That works out to be about $250,000 USD he "sells" in order to "buy" about $200,000 units of euros (it's a long trade). So, he just leveraged 25:1, and he is risking $200 on this trade should the trade drop 10 pips and get stopped out. That's 2% of his 10K account at risk.

 

Now, say that same trader, on a seperate trade, has another account with 10K in it. He again goes long in the EUR/USD, and he risks $200 on the trade, which is 2% of his account total. HOWEVER, rather than take a 10 pip stop, he takes a 200 pip stop (and a 201 pip target...whatever)

 

In this case, he is risking only $12,560 units (give or take)... so, he is leveraged about 1.25:1. Almost just 1:1... in other words, it's almost no leverage at all.

 

HOWEVER, his risk has NOT decreased at all! he is still risking 2% of his account. he is still risking $200.00.

 

in one example, he is leveraged about 25:1. in the other example, his leverage is barely more than 1:1... yet, his risk has not changed a bit. (unless you count slippage, which as I said earlier, if slippage is an issue, it's not your slippage, it's your broker)

 

So, unless you can show me a way that this math is wrong, or not relevent... then i'm gonna go ahead and say, no, more leverage does NOT necessarily mean more risk.

 

More risk means more risk. More leverage means quite simply a larger or smaller change to amount of investment capital per unit of market price fluctuation.

 

The words are not synonyms of each other.

 

It's like saying "more horsepower in a car makes for a more dangerous car". No. that's simply not true. If you drive the speed limit everywhere, always use your turn signal, never make an illegal lane change, never drive drunk, and always watch the road... well, i dont' care what your horsepower in your car is, you could have 1000 horsepower in your ferrari... your actually about as safe as you ccould be.

 

and your in fact MUCH SAFER than the new teenager with a license who gets drunk for his high school prom and tries to race his buddies to the illegal night club after the dance. That guy could manage to wrap his 130 horsepower toyota around a stop light. But the little old lady obeying every traffic law in her 1K horsepower ferrari? ya, that's simply just never happen to her. she will never wrap her car around a pole, regardless of the horsepower.... ie: leverage.

 

SO in fact, the reality is leverage is related to risk, but in no way directly correlated to risk.

 

Again, if i'm wrong here... please point out where and how. I don't think there is much more to say, but would like to see someone show me where my logic is wrong.

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ForexTraderX

I think your assumptions are correct in many ways - a small account, plenty of liquidity, fixed margins, a stable market.

These are great assumptions that often get thrown out the window in the real world.......and the finance world is scattered with people who forgot these and decided they could amp their returns with extra leverage.

Your logic falls down on the one time it does not work.......eg; you have taken you 10,000 to 10mil - either with a very high win rate or lots of leverage......liquidity becomes an issue.

....and then unless you can only think in % and dont get flustered when a big drawdown occurs when you hit 10m and give back 20%.....etc......

 

I would think the only logic flaw you have is that there is a model v reality and when reality takes over thats all that counts.....eg; you wake up one morning, the brokerage firm you had your account goes belly up, the tax man is asking for his return on last years PL, you get a divorce and you get a margin call......:doh:

 

As I said (not to argue with you) - with enough assumptions there is no logic in the thoughts, but if you choose to ignore (and not saying you dont recognise them) the risks that extra leverage can give you then I think you are being the little old granny in the Ferrari - not using the horsepower, that gets cleaned up by the speeding kid in the 130 hp s...tbox. :)

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ForexTraderX

I think your assumptions are correct in many ways - a small account, plenty of liquidity, fixed margins, a stable market.

These are great assumptions that often get thrown out the window in the real world.......and the finance world is scattered with people who forgot these and decided they could amp their returns with extra leverage.

Your logic falls down on the one time it does not work.......eg; you have taken you 10,000 to 10mil - either with a very high win rate or lots of leverage......liquidity becomes an issue.

....and then unless you can only think in % and dont get flustered when a big drawdown occurs when you hit 10m and give back 20%.....etc......

 

I would think the only logic flaw you have is that there is a model v reality and when reality takes over thats all that counts.....eg; you wake up one morning, the brokerage firm you had your account goes belly up, the tax man is asking for his return on last years PL, you get a divorce and you get a margin call......:doh:

 

As I said (not to argue with you) - with enough assumptions there is no logic in the thoughts, but if you choose to ignore (and not saying you dont recognise them) the risks that extra leverage can give you then I think you are being the little old granny in the Ferrari - not using the horsepower, that gets cleaned up by the speeding kid in the 130 hp s...tbox. :)

 

Siuya, i'll grant you that with more leverage, one does have to be more mindful of potential "black swans"... but having traded through a couple such situations myself (wrong side of the SNB intervention, and in yen when the tsunami and the market whipsawed several hundered pips in a matter of seconds, not to mention a BOJ intervention against me more than once)... I've never experienced slippage anywhere close to as bad as could ever do me any lasting harm.

 

Worst was the SNB, and I lost about 2.5X more on that trade than I had accounted for. which was less than 4% of my account capital.

 

If I really was leveraged big, one can always purchase out of the money options, or what not.

 

mind you, I would approach such a situation differently if I traded equities on a swing basis.... but equities are rarely leveraged much, if at all.

 

If I frequently held forex positions over the weekend, i may be concerened, but I don't do that either.

 

Had I been leveraged in my SNB slipped trade by a factor of 100:1... ya... that would have hurt. it likley woulda wiped out about 25%-30% of my account.

 

but if I was leveraged at 100:1...i'm gambling big on a percentage basis anyway. too big for most traders, and way too big for anyone that plans on staying in the game.

 

I think overall, one has to know that overleveraging is bad. but honestly, other than that single point, i'm not seeing it. we may have to agree on most points, and also agree to disagree on the importance of considering leverage amount when compared to other metrics by which risk and performance can be measured.

 

and as far as big leverage on large dollar sums... it doesn't exist. at taht size of the game, it becomes an issue of capital preservation and incremental, low risk growth. no one is leveraging 10 million up 50 to 1. No one is even leveraging 10 million up at 10:1. And if they are, they are arbing and hedging the snot out of it because that is how the game is played at that level.

 

multiple studies have shown that the larger ones account size is, the less leverage is used...and this is a fairly consistent direct correlation between leverage (or the lack of), and account size.

 

I could go even further as to say that the amount one will make by basically ignoring leverage and just focusing on risk per trade will generate more money a black swan or rare adverse market condition will lose due to that leverage amount...unless of course your risking 10% per trade. which is actually my whole point.

 

Again, it seems that this isn't really important anyway, it may be splitting hairs on such an irrelevent level that it's not even worth continuing the discussion.

 

I mean, if risk was some unknown boogie man in a closet that hides in shadows and couldn't be seen until it was too late...then ya, leverage would really matter.

 

but it's not. stop losses work in all but the most extreme situations, and if your keeping your risk down to 1 or 2% per trade (or less), than those extreme situations could push the market 2, 3 4, or even 5X past your stop. so, you lose maybe 5 or 10% on that situation. Fine.

 

if you were trading with no leverage, but 1 or 2% risk, it would have been a very similar result.

 

At any rate I think this is dead, at least as far as i'm concerened.

 

If there are those who want to pay a great deal of attention to the amount leverage they are or arn't using, that's fine by me.

 

I just stay away from markets that can be highly volatile, such as biotech stocks, and many emerging market equities taht I don't understand. I also don't sell naked options unless I want the underlying at that the strike price anyway.

 

in doing so, i've been able to completely ignore levearge amounts for years now, and it's yet to have any impact on my trading results, black swans or no black swans.

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FWIW -

the last few weeks i have spoken to a couple of people who have recently retired from some of the larger investment banks - (and when i say retired i mean that - they have not been retrenched - they just have enough money to walk away....aged 40-50 yrs) they worked in the trading and derivatives side of their business. They all love the markets, will continue to trade and invest.....

 

All of them talked about various things and the one thing that struck me that they all focused on was the question - how do i get 12-15% on their money without a lot of leverage.

They are happy to use it and know when its appropriate....but their leverage numbers are along the lines of 2 to 4 times, occasionally ten times when well hedged.

 

When I asked them if they are interested in higher leverage with risk controls etc; they all laughed and said even if you get it right a lot its the excessive leverage that will get you in the end.

The other thing they were all very aware of is the key thing is to avoid over trading.

 

Different mindsets of course....but maybe there is something in that for all of us :)

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FWIW -

the last few weeks i have spoken to a couple of people who have recently retired from some of the larger investment banks - (and when i say retired i mean that - they have not been retrenched - they just have enough money to walk away....aged 40-50 yrs) they worked in the trading and derivatives side of their business. They all love the markets, will continue to trade and invest.....

 

All of them talked about various things and the one thing that struck me that they all focused on was the question - how do i get 12-15% on their money without a lot of leverage.

They are happy to use it and know when its appropriate....but their leverage numbers are along the lines of 2 to 4 times, occasionally ten times when well hedged.

 

When I asked them if they are interested in higher leverage with risk controls etc; they all laughed and said even if you get it right a lot its the excessive leverage that will get you in the end.

The other thing they were all very aware of is the key thing is to avoid over trading.

 

Different mindsets of course....but maybe there is something in that for all of us :)

 

- 12-15% per week, month, quarter, year?

- Did these retirees mention the size of the capital they were trading?

 

1:10 leverage with $1-10 mil is probably a different expectation than 1:10 leverage with $1-10k.

 

The institutional mindset on leverage does tend to be much more conservative than the retail side. I suspect the large part is the starting capital. Another part is how retail sales reps advertise vs how institutional traders are recruited.

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I cannot find the link and I do not remember the name now but a well-known blogger and trader has shown with math that leverage above 3x is plain disaster. I think so too. High leverage is a compensation scheme for brokers and market makers to take the money of the newbies.

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- 12-15% per week, month, quarter, year?

- Did these retirees mention the size of the capital they were trading?

 

1:10 leverage with $1-10 mil is probably a different expectation than 1:10 leverage with $1-10k.

 

The institutional mindset on leverage does tend to be much more conservative than the retail side. I suspect the large part is the starting capital. Another part is how retail sales reps advertise vs how institutional traders are recruited.

 

sorry...my bad. per annum.

I sometimes forget the only ones who tend to speak in % other than pa as the default are retail day traders... :)

These guys look to do less trades, and the ones they do have small drawdowns, good upside and are less likely to be day trading....they also generally hedge.

 

You are right about it being a different ball game if you have larger pots of capital....but people should also take note that often these guys have lots of trading experience, seen lots of other traders come and go, they have naturally become more conservative with their own money than with others. (and maybe so should all of us)

.....and given they are institutional and according to many - the smart guys in the room - maybe just maybe its still worth while listening to....but it certainly does not fit the sales reps, or the dreams etc.....

 

as i mentioned....FWIW.

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