Using Leverage In Your Trading – How To Do It Right
Just quickly following up on a few questions we’ve had in the Q and A about leverage and whether we have any specific tips on how we can use it in our trading.
So obviously, leverage is one of the most important factors we need to understand as it relates back to our overall risk management. And without using leverage correctly, it can be enough to sink even the most successful traders out there.
So it’s not only about being able to find high probability trading opportunities with your fundamental analysis, but it’s also about being able to keep that money, right? Being able to capitalize on those high quality no-brainer trades and being able to manage your risks successfully.
Now, something that we always advise traders to do, especially if they are new to trading, is to trade without using any leverage. So that means trading at a one to one leverage.
Now that does not mean that you need to have a trading account that only allows one to one leverage because not many brokers will allow you to basically cap your account to such a low leverage.
So you can have an account with any leverage, 100 to one, 400 to one, whatever. It doesn’t really matter. What matters is how much you risk when you actually do your position sizing on that account. So you can choose to trade one to one leverage while having an account that allows you to trade 1,000 to one, just as an example. So the only thing we mean with trading without leverage is that you’re only trading with what you can afford to trade with.
So if you’re trading without leverage, it means that you can only risk or trade a micro lot for every $1,000 in your account. That means you can only trade a mini lot for every $10,000 in your account and you can only trade standard lots for every $100,000 in your account. So that way, you’re always keeping your risk manageable and of course keeping your risk low.
Now keep in mind this is a good approach for dollar based major currency pairs as that would mean that you’re risking about 1% of your account for every 100 pips moves. But a very important point to keep in mind always when you’re trading is volatility.
So volatility is different across currencies. It’s different across asset classes. So if you want to get really granular with your risk, you will want to consider beta adjusting or volatility adjusting your position sizes. So that means you’re always using lower leverage on any particular trade and you’re keeping that volatility in mind.
So let’s just take a very quick example on something like the Australian dollar versus the US dollar. So if we’re gonna trade one to one leverage on this pair, and let’s suppose I’m entering at the 65 60. And let’s just say I’m gonna place my stop loss at the ADR low for whatever reason. Now that gives me about 50 pips.
Now at a one to one leverage, that means that I’m risking about 1/2% on this trade. Now, if I can pay that movement in the Aussie dollar versus the US dollar to something like the pound versus the yen, for example. Let’s say I’m gonna take an entry at this support structure at 132 30. And I’m gonna place my stop also at the ADR low.
Now I’m suddenly risking 115 pips. Now at one to one leverage, that’s gonna mean I’m risking over 1% on this particular trade. So to help with that, what you can do is you can try to beta adjust your position size to the volatility of the instrument that you’re trading.
And that way, you’re always gonna make sure that you’re not over-risking or over-leveraging on any specific instrument or any specific pair just because the volatility might be higher than some of the other pairs or instruments that you’re trading.
So a good reason to also use a lower leverage per trade, has to deal with your margin requirements for your account, right?
So if you’re trading with leverage, you’ll always need to consider your margin requirements from your broker. So traders that take trades at 200 to one leverage, for example, stand a much higher chance of facing a margin call because they’re massively exposed to the volatility in the market, right?
So they’re so over-leveraged that their account can easily fall into or below the margin requirement and basically force them to take a margin call. Another reason why using no leverage is better is because you will face losses. Losses is unavoidable in trading. And you will have losing trades. And you’ll also have periods where you suffer some extended drawdown. So if you keep your risk low per trade, even if you use a little bit of leverage, right?
Let’s say you use three to one leverage. Three to one leverage can still sink your account if you end up taking 10 losses in a row. Just to give you an example. So it’s always good to make sure that you keep the bigger picture in mind when you allocate risk.
Also keep in mind that using no leverage should be applied to the normal type of trade you’re taking in line with the same sentiment. So if you’re trading risk sentiment on a day like today, for example, right?
So let’s say we have the strong risk on sentiment in play that we’re having and you want to diversify that. So you want to trade the Aussie/US dollar to the upside. You want to trade the Aussie/yen or let’s diversify. Let’s say you’re trading the Aussie dollar, you’re trading the Kiwi/yen and you’re trading the CAD/Swiss for example.
All of them are expected to move up in line with that risk on sentiment. Now, if you’re gonna trade one to one on all of them, you’re actually not risking one to one. You’re actually risking three to one on this trade because all of them are subject to the risk sentiment that you’re trading. So if you want to diversify, basically trading different pairs on the same sentiment, always make sure that you’re reducing your risk accordingly to make sure you’re also risking one to one.
Now, that is just for your regular type of trades, right? Obviously there are times when there are going to be super high quality, no brainer trades. The type of ones that only occur a couple of times a month. For those type of trades, you can decide to increase your leverage slightly to maybe two to one or maybe even three to one if it’s a really, really high conviction sentiment shift that you know will move the market.
Now obviously, for most traders they’ll only be able to spot those type of trades once they’ve gained some experience and once they’ve traded with the fundamentals for quite some time, they’ll know exactly when those type of events take place.
So what professional traders do is they keep their leverage low on the more common type of trades, but they then add leverage to those really clear and great high quality opportunities. And that’s how they usually grow their accounts a lot faster than novice traders by even keeping their leverage very low.
So that’s just a couple of tips, couple of reminders on how we use leverage. Any other questions on the subject, please make sure to let us know.