The Thing About Leverage Is...

It's hardly surprising that in the course of sharing one's experiences as a trader, that we encounter other traders with their own take on various state of affairs concerning FX.

In my professional working life, I've personally met institutional traders with such huge egos and personalities that they would literally suck the life out of any room they enter. Notwithstanding, I respect and admire them for their abilities and success as traders... and truth be told, I still keep in touch with a few of them.

The ones I consider to be really, really good can consistenly achieve an annual unleveraged return in excess of 15%. Though I'd love to claim that I belong to this category of traders... I unfortunately CAN'T. Though I've actually had a 15%+ year once... my average annual unleveraged return over my 12-year career is a more modest 8%. So, at best... I consider myself to be AVERAGE.

Retail traders, often those without institutional trading experience, also have their fair share of egomaniacs and larger-than-life personalities. It doesn't surprise me, for it is hard not to feel a little bit proud if one is able to double one's trading account on a monthly basis!

But the point that most seem to miss is the role of LEVERAGE. A retail trader will have their gains or losses amplified because of it.

Take a retail trader that doubles his account in a month... say, he's managed to turn his USD10,000 account into USD20,000. Wow! A fantastic 100% return. Good... but not so fast. Let's strip down the numbers.

The question that needs to be asked is, "how much leverage was used to make that USD10,000?"

At 200:1 leverage, the retail trader had in fact USD2,000,000 (i.e. USD10,000 x 200) available for him/her to trade on a daily basis (ignoring reinvestable profits) in order to make USD10,000. USD10,000 from USD2,000,000 is only 0.5% per month or 6% per annum!

PLUS... trading a USD10,000 account (with a notional USD2 million) is a far cry from trading a USD200 million unleveraged account with all it's inherent challenges & complexities.

I don't doubt that there are serious retail traders out there who have managed to achieve sustainable 'fantastic' returns. I salute them without reservation. But, we need to keep things in perspective.

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Fixed Ratio Money Management

It's been a while since I last blogged about Money Management, what many consider to be the most important yet overlooked subject in trading. As one of the three (3) pillars of trading success (the other two being Mind and Method), I therefore feel that I have an obligation to share more of my thoughts on the matter.

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