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Ask Your Advocate: What is Optimum Leverage for the Online Trader?

13 Years ago | November 25, 2013 1/28/23, 12:00 AM

Question for the Advocate:

What is the optimum leverage for an online trader and what is considered overleverage?




Your Advocate Says:

jay meislerThis is one of the hardest questions to answer as it is a key to proper money management and staying in the trading game. The answer depends on several factors, including one’s personal risk profile, trading performance (i.e. average gain vs. loss on trades, winning vs. losing percentage, level of experience to name a few.  It is the lure of big profits that causes too many to use high leverage.

It is hard to suggest an optimum trading leverage level as there is no one size fits all number. For new traders, leverage should be kept low (e.g. 5-10%) as they learn to trade. For more experienced traders, they should be able to figure out what leverage works for their approach. What all traders should keep in mind is what percentage of capital they are willing to risk on a specific trade and adjust the leverage accordingly based on the risk/reward for that trade.

For example, using forex leverage, your account has a $3000 balance and you are willing to risk 3% (= $90) on a trade. You are looking to sell EURUSD at 1.3610 with a stop at 1.3655 and take profit target at 1.3515. Your risk/reward is therefore 2:1 (95 pip profit target with a 45 pip stop). What leverage should you use? The answer is calculated by size of trade x .0045 = $90, which comes to EURUSD20,000 = 6.7% leverage (EURUSD20,000 x .0045 = $90). It is simple algebra to calculate and a way to add discipline and a professional approach.

Strategy Using Leverage:

This discussion reminds me of a highly successful trader who I knew many years ago. His approach was to only increase leverage after he built a cache of profits and when he saw the odds of a trade highly in his favor. What he would do is build a profit cushion so he could go for a big trade when he saw the risk/reward line up in his favor. He generally did this a few times a year with ”house money” rather than going for the home run with high leverage on each trade.

So to sum up, adjust leverage to make sure you stay in the trading game. Remember, the lure of big profits can also lead to large losses.

 

Have questiions? Send them to jay@tradersadvocate.com

 

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