Many times you hear or read that leverage is a bad thing that should be avoided. The often spoken sentiment is that smaller amounts of leverage are a good thing; that it will protect you. But is this the case?
In my opinion leverage can be good if you’re a trader and not a gambler.
For a trader, how can you use leverage to your advantage?
An effective money management strategy is essential. That is, always risking a maximum amount of your trading capital per trade. Providing you have sufficient capital to trade with, this is usually anything up to 2% of your trading capital per trade, depending on the volatility of your system.
A trader knows exactly the maximum amount they’re risking on each trade.
The trader understands the system they’re trading and has an idea what they can expect in terms of how many net trades may go against them, before the system moves on to a higher peak in it’s equity curve.
Based on this assessment of anticipated system drawdown a trader can evaluate how much should be kept in a brokers account to trade. The amount should be based on:
- The expected net trade drawdown.
- Margin required to hold open trades (impacted by how many trades are held simultaneously).
- Plus an additional buffer.
The larger the margin you obtain from your broker, the less funds you need to have in your trading account to cover your trades.
Being a trader is a risk management business first and foremost. By managing your downside risk you expect to make a (superior) return.
One often overlooked risk is broker risk. That is, the risk that you have on the money held with a broker. In recent times of economic downturn and uncertainty this can be quite high. We have all heard of brokers that have gone bust leaving traders to wait to see whether they can get all, part or some of their trading capital returned. It is paramount that trading capital is preserved, so action needs to be taken to reduce broker risk.
Broker risk can be reduced through the use of leverage. The higher the leverage is the less money needs to be left in the brokers account. I’m not suggesting you should trade with money you don’t have. I’m suggesting that with higher leverage you can park what funds you don’t need in your trading account in a deposit account with the bank. You can always transfer funds to/from the bank account whenever you like, usually with ease.
Depending on the currency, the bank account will often receive interest which increases your overall return. As most brokers’ accounts earn no interest or an amount less than what you can obtain from a bank, why not get a better return while holding funds in your own name with the bank?
Standard leverage on spot FX trading is usually 100:1. Some brokers can offer up to 500:1. Don’t be afraid to ask for more than their default amount. The safety of your trading funds is essential to keep you trading for years to come.
- What do you think about leverage?
- Do you leave your entire trading capital in the brokers account?
- What leverage are you comfortable with?
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About the Author: I’m Rachel Hunter, TraderRach, a Forex Trader who helps traders achieve the life they love with forex. Be strategic and design your trading business for sustainable success and have fun! That’s my mission. Join many traders’ gaining the edge with “10 Powerful Lessons for Forex Trading Success” plus other goodies. Years of precious learning specially packaged up for you. My background before trading is as a Chartered Accountant and Chief Financial Officer. I know what it takes to make a trading business rock on. It would give me great pleasure to make a difference to your success.