Hi guys, hi from Andrea Unger! Today, I’d like to talk about the leverage in trading, and more in detail about the use of leverage to size positions, which I consider quite dangerous.
Sometimes, people ask me how much leverage I use. Honestly, I think this is a really dangerous question. It reveals a wrong approach to trading, as it suggests a desire to maximize the money we have on our trading account.
If we want to maximize the effects of this money, it’s obviously because we think about potential profits only. Whereas thinking about profits is obviously fine, starting with this in mind is part of a wrong approach. That’s why I suggest that you adopt a different attitude. In fact, successful traders start by thinking about losses and take profits into account only as a second step.
When you open a position, you should size it resting upon how much you could lose if things went wrong, so that a certain level of losses is never exceeded in your account. Let’s say you have a $10,000 account and decide – as I always suggest, because it’s a good rule – to risk no more than 2% of this balance for every trade. The 2% of $10,000 is $200. This will be your position.
For instance, if you use a full lot on Forex, and that full lot has a 50-pip stop-loss, you know you would lose $500. So, how should you size your position in order to have a stop loss of $200 instead of $500? A full lot is clearly not the right choice, so you should work using a certain number of mini lots or, in some cases, micro lots.
My advice is that you create an Excel spreadsheet that will help you calculate everything automatically.
How much are you prepared to lose? This is the question you need to ask yourself when you size your positions. Look at the rules of your trade, the ticks or pips depending on the instrument, and the stop-loss you want. How large or small can your position be to keep losses within the limits you want?
The limits are subjective, because they depend on your risk profile. However, I always suggest that you keep these limits very small, not only at the beginning, but also later on. A 2% is already a bit bold, I think, but it is still reasonable.
So, I don’t know how much leverage I use. Really! Because I never start thinking about leverage. I know Futures are leverage products, so I checked my trades from time to time. On certain days, when I have many positions open and systems working, my margin requirements are about one-third of the total amount in my account.
This means I’m not running too fast, because one-third of the total account is obviously not too much. So, somebody could argue: “Yeah, but why do you keep all that money on your account, if you don’t use it? Why don’t you use it elsewhere?”.
The answer would take more than a couple of sentences, so perhaps I’ll explore it more in detail in another post. Anyway, to make it short, I need that account to size my positions the way I do. You see, I don’t actually need the money, but I need it as a reference point.
For now, just keep in mind that you should always start sizing your positions by thinking about losses first. Try to limit losses as much as possible, keeping them within a reasonable amount, where reasonable means something you can easily cope with. Then, if your strategy is well built, profits will take care of themselves.
Don’t think about leverage, think about how much you can afford losing, how much won’t kill your account, if you lose that once or more times in a raw.
That’s all guys, see you next time.
Ciao from Andrea Unger!