How much leverage should we use in trading?

I already spoke about leverage in other occasions but it is such an important issue in trading that I think I keep reminding other traders of it.

There are many myths surrounding this world of leverage, such as the one that says that binary options have not leverage, when in fact, as I wrote already, binary options are the most leveraged instruments in the world.

We also see numerous ridiculous claims in the world of Forex, CFDs or stocks and futures.

In all those markets we can see leverage promoted as the definitive weapon.

It seems that if we have a good advert with offers showing “high leverage” we are doing something “cool”, something that the supposed professional traders use to win.

Adverts such as:

  • “Day trade stocks with 4:1 leverage”.
  • “Trade Forex with up to 400 leverage”.
  • “Trade CFDs with 5% margin”.
  • “Trade the e-minis with USD 500”.

Those kinds of claims we can see quite often everywhere.

That is fine. That is what brokers offer.

Fair enough.

Although, do not you think that using that leverage is the way professionals make a living in the investing world.

Winning in the long term is very difficult.

Winning 15% every year as an average can be considered as something exceptional.

Evidently, to win a 15% annually you do not need to use 200:1 leverage.

People who use that kind of leverage think they can win 100% monthly; otherwise there would be no reason to use it. Right?

The fact is that that king of leverage is well linked to the day trading industry, its real market.

Why is it like that?

Basically because brokers and market makers make a living out of the day trading activity.

The more trades you do the more commissions they will make.

After all, they have some huge fixed costs to pay every month.

Simply think of the CEOs, managers, different employees, renting costs, furniture, and so on. You need a huge and constant cash flow to pay that.

A broker cannot make a living with ten customers who buy stocks and keep the positions for months.

The majority of brokers need thousands of customers trading daily frenetically to be able to get enough commissions to pay the big salary of one of their managers, for instance.

The reason for such a big leverage levels is because the brokers need to facilitate the maximum flow of trades and therefore potential commissions.

If the broker can find a trader that is willing to trade 10 times a day it will be perfect.

The experience tells me that the best way to invest in the stock market is doing long term investing with zero leverage. Simple.

If you are stubborn and still want to do trading it is best if you keep your leverage low, not much more than 5, or 10 at most.

Something more reasonable should be 2, 3 or 4 to 1.

Example of leverage in trading

For instance, I will say how I use leverage depending on circumstances and assets:

  • Long term investing, for instance in stocks: 1:1 leverage, obviously. This should be the majority of our investing funds.
  • Stocks: 2 to 3:1 leverage whether in stocks CFDs or just stocks. Also make sure to diversify your trading positions because one bad move in a stock can send your account to the bottom.
  • Index trading: you could try 6:1 or even 12:1 being bold and in some instances. But in general 6:1 would be more than enough.
  • Commodities futures trading: it should be around 5 to 10:1, and also diversifying to reduce risk.

All this I have just said as an example is of course not with day trading in mind, but thinking of doing some sort of swing or trend trading.

Those trades can last days, weeks or months, or even some years depending on the case.

It is important to note also that the personality, risk aversion and strategy, account size and more things have an effect on this issue.

However, I repeat: the closer we can have our leverage to 1:1, the best will be for us.

And you? How much leverage you use?

Original article: Cuanto apalancamiento usar en trading e inversion

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