Is high leverage really bad for traders?
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thread: Is high leverage really bad for traders?

  1. #1
    Member Rentt's Avatar
    32

    Is high leverage really bad for traders?

    Here's trading myth: high leverage is bad for you! You see this idea in every futures/forex forums over and over again.

    That is of course complete nonsense and this is the reason.

    Every time you start a 100 to 1 (or longer ) leverage stake in a forex mini-account, your favorable forex dealer is only saying this: Hey Mr. Trader, just put $100 on your account plus cost of disperse and I will let own $10,000 worth of currency, and if the market moves just 1% in your favor you earn 100% profit on your margin money, less price of spread along with a possible little interest!

    This high-leverage-is-bad myth is based on a very simple confusion the majority of traders, newbies (and some experts alike!) Assume that leverage means your whole trading equilibrium divided by the value of your position.

    Your trading equilibrium has of course NOTHING related to leverage!

    It does not matter if your trading equilibrium is $1,000,000 or $100, if you start a stake and you just want $50 to own/control $10,000 worth of currency then you're trading using a 200:1 leverage, period.

    So high or low leverage, it doesn't make a difference. HOWEVER, what is really, really important is the percent. If you open a forex position and you need $5000 margin money and that margin money represents 100% of your trading balance then Houston we've got a problem no doubts about that.

    In fact, if a trader has an superb forex trading platform, then the best course of action is to choose the highest leverage possible (400:1), to allow for a quick compounding of profits.


    PS: this thread is NOT an invitation to exchange using higher/lower leverage, as always trade at your own risk.

  2. #2
    Junior Member Refaco's Avatar
    4
    So let's say I start a forex position with $100 (that is ALL I have in my account) and that I control $10,000 worth of currency. What is the leverage?

    Right, 100:1

    Now let's say I tell you this over a beer: Hey Faure, you know what, I have $10,000 dollars just sitting and collecting dust in ANOTHER forex account with a different forex broker.

    Now you mean to tell me that NOW my leverage isn't 100:1 ANYMORE however 1:1 simply because I told you that I have $10,000 somewhere else??? Come on! What if I inform you that I lied, that the $10,000 is at the cookie jar in my kitchen am I trading with 1:1 leverage according to you?

    Leverage doesn't have anything to do with your trading equilibrium, nothing! It means how much money you may control with X amount of money, period. How much money you've got in your FX account, your bank account, your mattress or your attic doesn't have anything to do with leverage, nothing.

    That is exactly what FX is about: Give me $100 and I will let you have $10,000 worth of currency (100:1 leverage). Money is ALREADY in your FX account or how much money you wish to cable to your FX account each week/month is insignificant.
    Here - t take my word for it - see if you become aware of a definition everywhere in here.


    How much leverage if you use?


    Maximizing expansion without risking bankruptcy

    Many hedge fund disasters come not from making the wrong stakes -- which happen to the best people -- but from making too large a bet by overleveraging. On the flip side, without using leverage (i.e. borrowing on margin to buy stocks), we frequently cannot realize the full growth potential of their investment egy. So how much leverage if you use?

    Surprisingly, the answer is well-known, but little practiced. It's called the Kelly criterion. The leverage is defined as the ratio of the size of your portfolio. Kelly standard says: f should equal the expected excess return of the egy divided by the expected variance of the excess yield, or

    f = (m-r)/s2
    (The excess return being the yield m minus the risk-free rate r.)

    This quantity f looks like the familiar Sharpe ratio, but it isn't, since the denominator is s2, not so as at the Sharpe ratio. However, if you can gauge the Sharpe ratio, state, from some effects of a egy, then you can even estimate f just as easily. Suppose I have a egy with expected return of 12% over a period with risk-free rate being 4%. Let's state the Sharpe ratio that is expected is 1. It's easy to calculate f, which comes out to be 12.5.

    That is a shocking amount. That is telling you that for this egy, you should be leveraging your equity 12.5 times! If you've got $100,000 in cash to invest, and in the event that you think the values of Sharpe ratio and your returns, you should borrow money to trade a $ 1.2 million portfolio!

  3. #3
    Member Rocky's Avatar
    83
    So let's say I open a forex place with $100 (that is ALL I have in my account) and I control $10,000 worth of currency. What's the leverage?

    Proper, 100:1

    Right.

    Now let's say I tell you that over a beer: Hello Faure, you know what, I have $10,000 dollars just sitting and collecting dust in ANOTHER forex account with ANOTHER forex broker.

    You mean to tell me that NOW my leverage isn't 100:1 ANYMORE however 1:1 because I told you that I have $10,000 someplace else???
    Come ! What if I tell you that I lied, that the $10,000 is in the cookie jar in my kitchen instead, am I trading using 1:1 leverage according to you?

    From the aforementioned your point seems to be the money that is not in your account is irrelavant. I concur.

    Leverage doesn't have anything to do with your trading balance, nothing! It means how much money you may control with X quantity of money. Just how much money you've got in your FX account, your bank account, your mattress or your loft doesn't have anything to do with leverage, nothing.

    This is what FX is all about: Give me $100 and I will allow you to have $10,000 worth of currency (100:1 leverage). Money is ALREADY in your FX account or just how much money you INTEND to wire to your FX account every week/month is completely insignificant.

    That's where you are incorrect. Leverage is a multiplyer of the two risk/ return, that it exists. So there is a direct connection between leverage and risk/return. If you are going to quantify your risk/return contrary to your account balance why quantify leverage from the margin utilisation rate? Shouldn't you're measuring it from your account balance too. You don't say, Gee I created $10 off trading a mini-lot ($10 000) and the margin I want to exchange that was just $100 (1:100). I must have made 10%! , meantime your account balance was actually $10 000, your leverage was 1:1 and you just made 0.1%. The same point was made by leugimp.
    That's not what I am saying at all. All that matters is how much money is in the account. Not in the cookie jar, not anywhere else. Just in the account which you have used to make that trade and where the trading p/l will be reflected.

    To quote Leugimp:
    So I guess when you've got a 100K account together with 100:1 leverage offered and you also make $1000 dollars over the course of a calendar year, you'd state that you created 100 percent in that year - bravo - I can now tell my family that even though they are just up 15% to the year, they really are up 1500% on their margin money. What's the usage of this logic?
    It's all about your account balance not your margin utilisation rate.

    I am not trying to attack you I only want you to see where you are going wrong in your thinking.

  4. #4
    Member Rentt's Avatar
    32
    Here - dont take my word for it see if you become aware of a definition everywhere in here.


    Just how much leverage if you use?


    Maximizing growth without risking bankruptcy

    Lots of hedge fund disasters come not from making the incorrect stakes #8211; that happen to the best of us 8211; but from making too big a bet by overleveraging. On the flip side, without using leverage (i.e. borrowing on margin to buy stocks), we often cannot realize the full growth potential of their investment egy. So just how much leverage if you use?

    Surprisingly, the answer is well-known, but little practiced. It is called the Kelly criterion. The leverage is defined as the proportion of the size of your portfolio. Kelly standard says: f should equal the expected excess return of the egy divided by the anticipated variance of the excess yield, or


    f = (m-r)/s2

    (The excess return being the yield m minus the risk-free rate r.)

    This amount f resembles the recognizable Sharpe ratio, but it is not, because the denominator is s2, not s as in the Sharpe ratio. However, if the Sharpe ratio can be estimated by you, state you can also estimate f. Suppose I have a egy with anticipated return of 12% over a span with risk-free rate being 4 percent. Additionally, let#8217;s say the Sharpe ratio that is anticipated is 1. It is not hard to calculate f, which comes out to be 12.5.

    This is a shocking amount. This is telling you for this particular egy, you should be minding your equity 12.5 occasions! You should borrow money to exchange a $ 1.2 million portfolio if you've got $100,000 in cash to invest, and in the event that you believe the anticipated values of your returns and Sharpe ratio!
    I'm already familiar with the Kelly formula although I don't use it all in my trading. I use the much, much superior Fixed Ratio position sizing as clarified by R. Jones.

    That is said Kelly's definition of leverage has of course nothing to do with FX, we're just playing with words here.

  5. #5
    Junior Member Refaco's Avatar
    4
    I'm already familiar with the Kelly formula although I do not use it all in my trading. I utilize the much, far superior Fixed Ratio position sizing as described by R. Jones.

    That's said Kelly's definition of leverage has of course nothing to do with FX, we're simply playing with words .
    You are just too funny - I can't tell if a schitzo lawyer or a highschool prom queen.

  6. #6
    This is a another normal trading myth: large leverage is awful for you!

    .
    Since this is in the beginners section, I'll respond. :

    High leverage is awful for new traders. It gives them the impression that they are capable of greater than they are. In a 400:1 account, a new trader with $500 will say, I'll use just 1/4 of my account to trade. Of course, one trade of -50 pips will stun a new trader. As you know, new traders arrive with a fantasy... not the belief that they'll get hammered their initial trade. Now that they have just $250 left in their account... they'll actually bet that previous half to attempt to get the $250 they had just dropped.

    However, if leverage to the newbie was just 20:1, 10:1... they might in reality say I'll use all my account. Their very first transaction they would still lose -50pips, however, they would be sitting on $450-$475 account balance and would continue to be able to maintain that fantasy they had. This would also be a learning experience for them... rather than a devestating blow to their hopes.

    Now, a seasoned trader would get that 400:1 account and simply say I will trade 5% of my account balance to start. If he loses the 50 pips, he will be in the exact same position since the newbie with 20:1.

    I am just trying to provide a perspective here. I've spoken with enough of my peers to understand that they were thrown away from the leverage bargain. They literally had no idea that they would get hit so hard. Traders that know what is going on have nothing to dread of leverage.

    So new traders... trade micro lots... not minis. Do not ship in $500 to a broker that lets you trade minimal $1/pips. Your fantasy not just will last longer, it may just last long enough to actually come true.

  7. #7
    Member Rentt's Avatar
    32
    Because this is from the beginners section, I will respond. :

    High leverage is awful for new traders. It gives them the belief they are capable of more than they really are. In a 400:1 account, a new trader with $500 will state, I will use only 1/4 of my account to exchange. Of course, 1 trade of -50 pips will stun a new trader. As you know, new traders come with a dream... not the belief that they'll get hammered their first trade. Now they have only $250 left in their account... they will actually gamble that previous half to attempt to get the $250 they'd just lost.

    However, if leverage to the newbie was only 20:1, 10:1... they could in fact say I will use all my account. Their first transaction they would still lose -50pips, however, they would be sitting on $450-$475 account balance and would be able to maintain that dream they'd. This would also be a learning experience for them... rather than a devestating blow to their hopes.

    Today a veteran trader would get that 400:1 account and just say I will exchange 5 percent of my account balance to get started. If he loses that same 50 pips, he'll be in the same position as the newbie with 20:1.

    I am simply trying to give a view here. I've spoken with a lot of my peers to understand that they were thrown off from the leverage deal. They literally had no idea they would get hit so hard. Traders that know what is currently going on have nothing to worry of high leverage.

    So new traders... trade micro lots... not minis. Don't send in $500 to a broker that allows you exchange minimal $1/pips. Your dream not just will last longer, it may only last long enough to really come true.
    For the last time, it isn't important if you have just $100 in your FX account and start a 100:1 leverage position but mean to wire a total of $50,000 for your FX account through the years or if you start a FX account with $50,000 immmediately and just open a 100:1 position using $100 margin cash.

    Most traders will state Hey the first solution is VERY BAD, you are way overleveraged while in the second choice they'll clap and say Wow, very conservative move, fantastic trading choice! .

    Actually, BOTH trading decisions are IDENTICAL and will not make a damn difference in your trading results/profits, this is what I am attempting to explain folks.

  8. #8
    For the last time, it isn't important if you have only $100 on your FX account and start a 100:1 leverage place but intend to wire a total of $50,000 for your Foreign Exchange account through the years or if you start a Foreign Exchange account with $50,000 immmediately and only open a 100:1 place with $100 margin cash.

    Many traders will say Hey the very first solution is VERY BAD, you are way overleveraged while at the second choice they will clap and say Wow, very conservative move, very good trading choice! .

    Actually, BOTH trading choices are IDENTICAL and won't make a damn difference on your trading results/profits, this is precisely what I am attempting to explain people.
    Was this in response ? I really don't follow if it is. All I'm saying in my article is that you will find people who open an account with $500 and that is simply. They will never ship in anything or 50k of the type. If you mix that handicap with the simple fact that they've 400:1 leverage, they will be at a lot of difficulty. You don't agree?

    The original article was asking the question regarding whether high leverage is bad. It is if you are a newbie who has little concept of what is going on. If you chose that high leverage out and made them trade 20:1, 10:1... there are a lot of people still clawing their way through the market. Since they had to trade more these individuals may have actually made something of themselves. This as opposed to simply gaming a couple trades.

    That I have no debate regarding the structure of an account along with its impact on leverage. All I understand is... when an account has a $0 balance... it won't be trading much anymore.

  9. #9
    Junior Member Copipk333's Avatar
    17
    I am already knowledgeable about the Kelly formula although I don't use it at all in my trading. I use the much, much superior Fixed Ratio position sizing as clarified by R. Jones.

    That's said Kelly's definition of leverage has of course nothing to do with FX, we're just playing with words here.
    I nearly died lauging once I read this. Not because of its wrong or something.

    Its only funny!

  10. #10
    Junior Member Refaco's Avatar
    4
    For the last time, it does not matter if you have just $100 in your FX account and start a 100:1 leverage place but mean to wire a total of $50,000 for your forex account over the years or if you start a forex account with $50,000 immmediately and just open a 100:1 place with $100 margin money.
    In your case - the leverage used at the next part is not the same as the leverage used at the first part. But lets assume that it is. 100:1 leverage standing on $100 account will make it possible for you to exchange 1 10K lot. If the market moves 1 percent against you, you will have murdered the account. Now lets say that it does not and your money double . At this point you have $200.00 - if you use 100:1 leverage and exchange two 10K lots - a 1 percent move against you and your account is at zero. A 1% movement in your favor will double you up again. The point is if you use the complete amount of leverage available for you, you will always risk your entire account on any 1% movement against you. This is true wether you have a account or a 50K account.

    That's all assuming you are utilising the maximum leverage readily available to you which was exactly what the discussion was initially. What you are suggesting here is that wether or not you have $100 or even 50K you are still just trading 1 lot. This is not as bad as the first situation because if you double your money a few times by the fifth trade you will already be using 25:1 leverage as opposed to 100:1 - still high but much more manageable. And at this stage it isn't important if you deposit your 50K today or later as you are never scaling down or up (although an opportunity may pass you by while waiting to fund the account). From the bill gates instance as in every one of your cases, you imply using each of the leverage available for you, in which case 100: leverage utilisation is just plain suicidal. That would interpret trading 500 10K lots with 50K. Again a 1% move from you and you are completed - an eventual certainty in that situation.

    Dont take it to heart though, I know you had good intentions all along and that I apologize for any offense I may have made. I really don't believe that you are stupid either, special is more the term.

    Good day

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