Leverage is a trader’s most powerful weapon
When to use leverage
Leverage
is the use of borrowed funds to amplify returns from an investment. You can see
various brokers providing a particular amount of leverage based on the
regulatory jurisdiction. For example, in the EU brokers provide a 1:30 leverage
for the major forex pairs, that means that for every dollar you can control up
to 30 dollars.
In
order to use leverage you need to provide some margin, that is kind of a “good
faith deposit” as a collateral. So, if you have a 1:30 leverage account, that
means that you need to provide 3.3% worth of your trade size. For example, if
you want to open a trade worth 100.000$, then you need to provide 3.300$ as
margin and the rest will be covered by the broker.
It’s
worth mentioning that leverage can both amplify profits and losses, so you need
to know well how to use this tool and especially when to use it.
All
successful traders make use of leverage and they risk different sizes depending
on the opportunities. It’s never a fixed size for everything. You should use
leverage only when there are kind of no-brainer opportunities in the market.
Those times when your conviction is so high that you are absolutely comfortable
entering the market with a bigger size.
There
are times when something happens that the market didn’t expect and if it’s in
line with a prevailing fundamental theme, then you will see the price moving in
a sustained way in the direction of the surprising development. For example,
the June FOMC meeting delivered a hawkish surprise both from the Dot Plot and
the Powell’s press conference where he acknowledged that inflation “could be
higher and more persistent than expected” contrary to the previous “confident
that inflation is transitory” remarks.
The market responded immediately and in an
aggressive way as you can see in the EUR/USD chart below.
The EUR/USD pair sold off for 250 pips in 2
days and the pullbacks were really shallow. This is how the market responds to
surprising developments. These opportunities are quite rare and that’s why you
should take full advantage of them. Risking small on such type of opportunities
just feels wrong.
There are two legendary traders known for
making large concentrated bets when they have a high conviction in their
trades: George Soros and Stanley Druckenmiller. They are famous especially for
the short sterling trade that “broke the Bank of England” and netted them an
estimated 1 billion profit. Stanley once said that he went to George and told
him that he wanted to short using 100% of their capital. George looked at him
with disdain…because he wanted to use 200%!
To sum up, leverage is not something you
should fear or use randomly, it’s the most powerful weapon you have as a trader
if you use it correctly.
