Let's look at this practical forex example: My EUR/NZD Strategy requires at 50:1 leverage 70,162$. At 400:1 leverage, the same Strategy requires only 18,596$. The difference is 70,162 - 18.596 = 51566$. Now the 51,566$ can be used for other purpose, which allows a much more efficient use of the available capital. The risk stays the exactly the same in both cases, the only difference is that less money needs to be deposited. This example is from Forex, but same concept applies to to stocks. Of course in stocks you won't get that high leverage as in forex, maybe just 5-1 but the concept is the same. So many people look at high leverage as a bad or outright dangerous thing, which it really isn't.
I totally agree, however, using leverage in that instance and going "all in" or using excessive leverage on ETFs and Stocks which are a lot more volatile than currencies. a 1% move seems a lot to forex traders, but think about using that leverage intraday on equities & etfs. I used a currency to make it a bit easier to understand. Maybe I should have done it with IBM or AAPL to demonstrate that.
Just going out on a limb and saying if a trader doesn't understand the risk they take to either adding to or taking a large position in something... they won't last very long at all. The market is the ultimate teacher of risk. Every trader in "the game" should have kind of understanding of that. I know this statement is very vague but it is also VERY true. One of the 5 or so prime rules of trading for a living (or even part-time or as a supplement) is always have a plan. Know how much capital your plan is comfortable with. Test your plan in various conditions and make sure it holds true (I'm a huge "odds" guy). I would think everyone on the ET board knows that 80 or 90 percent of traders aren't successful in their trading careers. This can be due to many things but, understanding risk is always a sure-fire point of that statistic. Leverage is not a bad thing but, as the old saying goes, too much of anything is a bad thing. When I interned at a prop (6 years ago), they only allowed new traders to start with 10 shares every trade... than 100... than 300... than 500. You would think traders would want increase their PnL and add more lots but, surprisingly, many of the traders at this prop didn't WANT to go over 500 shares of ABC stock. Of course, many props now have many ways to break in new traders but... you can see the point im getting at. My personal opinion (and take it with a grain of salt like I know you all are reading this post), leverage is like a drug....awareness to the public is key. Once you are aware, it's up to the trader ultimately to make their own decisions. Just my 2 cents (or 20). -OGTrader
That's a great way of putting it. Having a drink or two and watching the game at the bar can give you a great experience. Having 6 or 7 will get your head in the toilet for a couple of days.
Leverage can sometimes be inversely related to the size of one's account. Say a trader has 10k and really needs income to pay bills, etc...well, the only real way to even think about making 2-3k a month is with crazy leverage. It's funny how many have 10k and talk about making 100k a year. Or even 5-10k a month. Sure, it's possible, but with tons of leverage. I've never seen it done on an auditing basis on a consistent basis, but i'm sure someone has done it. My point is that some small accounts don't care much about 100:1 or 1000:1 or whatever the leverage is, since they know a 1 lot in the ES requires being right a lot with small losses to consider this a "business". Trading ES really requires 25k minimum, and 100k for stocks. Anything else is scared money. The reason people say you can do it for less is because they are likely selling you some system.
Fair enough. I think we are talking about different things. I was talking about portfolio leverage. You are talking about position leverage.
Using leverage and how much you invest into a strategy or system is directly related and I feel it is very important. Some say 1:500 or 1:1000 is simply gambling. I do not agree completely. Leverage related to capital can use a rather controversial application if one really considers the possibilities honestly. Most traders gamble with leverage. But consider this valid point: You need less capital in your account at 500:1. This is what it is all about. Your yield is always based on your capital. If you trade the same way on a 50:1 account vs. a 500:1 account then which account would be better? Do you see the point? To further expound...since there is less money at risk and he gets a margin call...it's just to replenish the account. The net comparison to trading at 50:1 is the same. If he is a loser..he is still a loser...BUT if he has an edge more leverage is the way to go...Just look at the model Prop Shops offer for professional equity traders...they would not be able to extract money from the markets without leverage and fast tools. Drawing lines in the sand may be an unnecessary evil. So there are many traders here that are professional or experienced that will admonish you to be careful and to lower your expectations and do not gamble. But when you examine yourself and your use of leverage you may understand that they mean well, but do not really understand. There are a lot of things posted on these forums that "sound good"..but you can go deeper and examine these "one-liners" and discover for yourselves what they mean to YOU.
Very well put as well. This kinda goes back to what Don said in the beginning. It all depends on what type of strategy you have as a trader.