Leverage is a strange topic to discuss in the trading world since it’s both over-feared and overused. On the one hand, you have people who say you should never use leverage. On the other, people who end up losing everything to over-leveraged positions.
Today, we’ll try and find a middle ground between the two. Leverage is an immensely useful tool when used properly, whether you’re splitting your capital or bolstering a single position.
However, it also has the gambling-like effect of always leaving you wanting more. It’s easy to get hooked on the feeling of profiting $100 from a $5 trade (of course, you could have also lost as much, if not more).
So here, we’re interested in setting some sensible leverage caps. Before we continue, we will set a few ground rules and assumptions.
First, you should never trade what you can’t afford to lose. That’s especially important with leverage since all your trades are amplified. Next, the rest of the text will assume your tactic can meaningfully benefit from using leverage. Some tactics, like buy-and-hold, often show less success when utilizing margin trading. We assume you’re being sensible and only using leverage when it can benefit you.
Beginners
For beginners, we feel an appropriate leverage level sits between 1:10 and 1:50. That depends on many factors, including how you use the leverage.
As a rule of thumb, you should use lower leverage if you’re propelling a single position. Simply put, a single trade has more chance to fail than a group of positions. And if your trade goes badly, it can incur massive costs.
However, if you’re using leverage to spread your capital across your portfolio, you may consider using more. Of course, you won’t be leveraging every position, but bolstering a few stable winners and a riskier position can provide a good bit of hedging.
And an additional note we’d like to add here is that you need to be extremely watchful regarding leveraged positions. Things can go wrong extremely quickly; if you aren’t watching, you may lose thousands within days. As such, set tight, take wins, stop losses, and monitor your platform.
Intermediate Traders
While you can always stick to the 10-50 leverage range and find great success, you may want more. When you become a more confident trader, upping that to 50-150 is an option. However, unless you have significant finances to fall back on, we’d recommend against going further than that.
Again, the same rule applies, single trades are more volatile than portfolios and have a higher chance of backfiring.
Final Thoughts
We could also go into some suggestions for advanced traders, but they likely already have more insight than we can provide in this short article. However, since brokers commonly offer leverages over 1:500, we’d like to add that there’s no reason for that. Unless you’re trading on behalf of a major company, there’s almost no reason to expose yourself to that much risk.
Lastly, there’s the argument that leveraging trades doesn’t increase their risk. It’s partially true since your earning percentages stay the same. However, losing fifty times more money than you otherwise would feel like a risk.
If you intend on using leverage, be sure in your strategy and use it responsibly.
