In Continuation with previous Article
Using Too Much Leverage
A trader should always take the concept of leverage very seriously, As many accounts have gone bust because of being overleveraged.
A highly leveraged trade can quickly deplete your trading account if it goes against you, as you will rack up greater losses due to the bigger lot sizes.
With this section talking about leverage I am mainly going to be referring to futures trading because futures provides the most leverage.
While there is no question that futures can be volatile at times, what individuals do not understand is that it’s not the volatility of the market that cause problems. It’s proven that most large cap big name stocks like Reliance,IEX actually have more volatility than the majority of futures contract whether it’s the Nifty, Bank Nifty, gold, oil etc… The problem is the amount of leverage one used with their money.
The difference between trading stocks and futures is the amount of capital required to enter a trade.
Leverage can be a sharp double-edged sword. It can work for you, or against you. Your Broker allows you to Buy 5 Lots of NF on 1 lakh capital and suppose you make 50 points in that trade so your profit will be 37.5 K (5*100*75 ). So on a capital of 1 lakh you made 37% return in single trade.While it is really nice to think about the money you can make, the money that can be lost is rarely discussed. Leverage can be very dangerous if used improperly.
Taking the above example Suppose trader is carrying 5 lot of NF and market open 150 points down trader will lose almost 56K which is more than 50% of his trading capital. Leverage is layman terms is Like Try to Drive a BMW when you do not know how to drive MARUTI
A loss of 10 percent requires an 11 percent gain to recover, which is quite manageable. However, as the loss grows, the size of the return needed to recover increases at a faster pace. Indeed, a 50 percent loss requires a 100 percent gain to recover and an 90 percent loss requires a 900 percent gain just to get back to even.
Consider this: with leverage of 400:1; you can control a 100,000 trade position in the market with just 250! This would mean that a 1% positive price change in the market will result in a profit of 1,000 (1% of 100,000). Without leverage, a 1% positive price movement will result in a profit of only $2.5 (1% of 250). This means that your trade positions and the resulting profits/losses are multiplied 400 times. This is why it is often stated that leverage is a double-edged sword. With trading leverage, profits are magnified, but losses can equally be devastating.
When Traders trade too big, he get headaches from not being able to take my eyes off the chart from one tick to the next in case there’s a sudden massive spike, and there’s nothing worse than wiping out you’re whole Week’s profit, in 1 bad trade.
Futures trading in my opinion is not for beginner or intermediate traders. The only way your money should be involved with futures is if you truly understand how the market move and have strict money management rules, or us a system that trades and managed positions for you. Remember, leverage is a double edge sword that can make you wealthy or broke quickly if not traded appropriately.
How to Avoid OVERLEVERAGE
A way in which you can try and void trading with too much risk is by having the properly account and position size. The key is to use just enough leverage on your money to generate above average returns while not exposing you to too much risk.
Of course trading with leverage come increased trading emotions.
As a trader Ideal thing to do is Learn trading strategy, back test it, Master it trade small, make consistently good profits week after week. Slowly increase leverage as you grown your trading account.A good time to use leverage is when adding to a winning trade. If you have a trade that has progressed favorably and you want to add to it, this is a good use of leverage. This is called leveraging your profits.
Using To Much Leverage Trading :
In short, if your trades will typically have a drawdown of say 20%, then you must be sure your account has enough money to be able to enter the same size position after lose 20% or your account. If you will not have enough money left to keep trading then either adjust your strategy or deposit more capital.
Sticking to a trading plan and constant analysis of mistakes are important. One should design a strategy for each trade. Position size is key to keeping the overall trading risk under control. One should not take a position without first establishing the reward-to-risk possibilities. One should understand the risk associated with a trade and one’s risk appetite before deciding on the size of leverage to use. Once the risk in terms of the number is known, it is possible to determine the potential loss of capital. And trader should not take losses in excess of 1-2 per cent of capital in a single trade.