Margin / leverage - the double edged sword?

[JumpOff]

I searched through this forum and could not find a thread devoted to this subject, so I have taken the liberty of starting one.

Many of the brokers and spread-bet firms offer amazingly low margin requirements. Some as low as 200:1 (!) I'm guessing that many new traders will need to use some kind of leverage when they get started, simply because their account size is below 10K and that's not enought to control even a mini contract outright.

The nature of the forex and other markets with high volatility means that by using leverage a small account could nearly double on a big move in one morning. (I'm not saying this is likely - just theoreticly possible) Conversely, - several wrong entries - even with tight stops could leave you with 20% or more of your capital gone that same day.

Several threads have included an admonishment to "never risk more than 1 or 2 % of your account on any given trade." Other threads in the general trading chat and forex forums have discussed the fact that licensed brokers won't guarantee your stops - they'll just do their best to get your stop loss (market order) filled at the best price in case of a gap.

Are there other alternatives for traders who are just getting started with small accounts? Are there licensed firms that offer mini-mini instruments?

For those of you who have been trading real money for at least a year, - did you use a margin account when you were starting? Do you still use it today? Any thoughts you'd like to tell us beginners?
JO

 

[donaldduke]

With leverage you can double your acccount and you can also destroy your account to $0.
The risk reward ratio is not worth it. Its effectively 1:1. You wont be able to realise your long term
expectancy (which can be as much as 10:1) if you using high leverage.

By using leverage and risking more than 10% of your account on one trade you are relying on luck and not
skill and so you might aswell go to a casino!

The advice to only risk 1-2% is sound.

If you have 5K dollars you can risk $100 dollars per trade Max (ie 2%).

So if you are trading daytrading 1 YM (Mini Dow) contract you can risk (ie set your stop at) 20 points per trade Max (YM trades $5 dollars per point).

You cant swing trade YM with 5K because your stops are likely to be much bigger than 20 points when
swing trading therefore you probably need atleast 5 times that to swing trade (so you can set your stops at
100 pips).

 

[JumpOff]

The advice to only risk 1-2% is sound.

If you have 5K dollars you can risk $100 dollars per trade Max (ie 2%).

So if you are trading daytrading 1 YM (Mini Dow) contract you can risk (ie set your stop at) 20 points per trade Max (YM trades $5 dollars per point).

So is it your opinion that some leverage is OK ? For instance, I am papertrading now, in an effort to determine the optimum size for a stop loss on several different instruments. My goal is to find the smallest stop that still makes sense. It has to big enough to account for noise, - if it's too small, I'll hardly ever get a trade that gains and all my account will be eaten up with comission, spread, and stop. So once I've figured out what kind of stop I want to use in points or pips or whatever, then my leverage should be limited to an amount such that the

(stop points * $per point) + comission + (spread * $per point) < = 2% of my account balance.

Did I get your meaning?
JO

 

[kevin546]

There are some that provide advice when starting out to risk even less at 0.25% until your results speak for themselves, this is especially true if day trading as you are likely to be placing more deals.

Kevin

 

[donaldduke]

JumpOff,

Yes thats exactly what i meant. I hope you are not planning on spread betting but using a futures
trading account (IB for example). The spreads charged by SBs dont make daytrading worthwhile.

Kevin546, Risking 0.25 at the start is probably a good idea if you have an account with say 50K+ init.
If you are starting with 5K then 0.25% is only about £10 pounds and isnt realistic.

If you only have 5K then if thats all the money you have in the world and its going to take you
a few years to save it up again, then its money you cant afford to risk and you shouldnt be trading
with it.

You really need a minimum of 10K dollars to handle a drawdown, 5K is probably not enough anyway.

 

[kevin546]

donaldduke

Appreciate where you are coming from with your comments. My point was made on the basis that many enter the market thinking they are ready when they are not. Paper trade all you like but it is not until you do trade that you find something out, its not as easy as it seems. If you are not fully prepared then by trading in small amounts will at least give you a chance to learn as you go rather than as some do who jump in and start getting it wrong. They then focus on how much they have lost and they start to trade with a greater % in order to win it back.

Unless the new trader comes to the trading area with everything ready and the ability to trade from anything the market may throw at him then fine, but how many are really at this level when they first start.

Persoanlly, if you method is not day trading then I would use spreadbetting as an early test because you can place very small amounts and would suggest this is what follows paper trading. After a resonable period of testing small amounts with SB's then I would move over to other conventional forms of trading and at appropriate levels.

You are quite right to be properly capitalised and I feel £5k is to low and £10k is far from ideal. I would suggest £20k - £50k is a better level.

 

[JumpOff]

Kevin546 and DonaldDuke,
Thanks for your thoughtful responses. Is it your opinion that people with larger accounts often do not use leverage?

Kevin, I am curious about your statement:

I feel £5k is to low and £10k is far from ideal. I would suggest £20k - £50k is a better level.

Are you saying a person can't learn to trade with less than 10K, or that in order to earn your living as a trader you need 20-50K to start.?
Thanks again,
JO

 

[kevin546]

Jo

This is only my humble opinion. If you are intent on trading for a living then I feel the more capital you have available for trading the better because it will take some of the pressure off. If you require an income then % gain on the sum you are going to use the smaller it is the harder it will have to work for you to get a good gain. This can cause a trader to hunt or chase a trade rather than trade it according to a plan.

I am not saying that someone cannot make a living with less just that you are giving yourself a better chance to succeed. Remember if this is to be your only source of income you need to know what you are doing and maintain discipline. Sway from this and your pot to return capital growth / income starts to reduce.

That is why I mentioned spreadbetting. Yes I accept in some ways due to the mechanics of trading through this medium it is actually harder but you can start with very small amounts to test and trade at the same time. I am a firm believer that if you can make money from spreadbetting then shares, futures and cfd's are a piece of cake.

Of course when trading it is not the amount you start with but the method you are to apply that counts, so starting with less than £10k is not the major factor. What I think people can overlook when they see a method working for them is they can become over confident. The market can change and one method may work very well during a trend but no so during a non trending period etc. A method has to take account of changing market conditions to safeguard your capital and income. The affect can be that your performance suffers so I feel the capitalisation helps when your performance slips. By having more capital and trading with sensible risk management then you can weather the storms. By reaching what you consider a max deal size and then maintaining it, or increasing at certain levels of progress but being prepared to reduce as capital decreases.

Remember emotions play a large part of your trading and the smaller your capital especially if you require an income from it the pressure will be higher the smaller your capital pot. It is one thing to lose the pot but another to have no income either, IMHO.

 

[Racer]

I don't think trading on margin is for beginners. You have to have a lot of control to be able to trade using that method. And as someone has already said, a small account can get decimated very fast and that will completely destroy your confidence as well as your wallet if you are just beginning