Forex Mistake #1000 – Leverage is Evil

Why Leverage Could Get You Broke?

Leverage is Bad, Leverage is Evil and it’s always destroying your account. Don’t use Leverage. I hear that sort of stuff all over the internet and everyone seems to look at Leverage as if it was the bubonic plague or the atomic bomb. Ever heard the phrase “Forex is risky”? Of course it is risky because the rewards are high and any instrument which can potentially bring high rewards has a high risk attached to it. The mainstream opinion about leverage is “Keep it low”. Mine is a bit different and I will try to lay it out for you.

 

Leverage Is the Culprit

“Oh, I heard he blew his entire account. He was probably over-leveraged…” Of course, that must be it: leverage. What else is to blame? Bad trading? Nope. Bad Stop Loss placement? Nope. Bad anything? No, no, Leverage must be the culprit. Well, guys, I don’t really agree with that but I want to show you how leverage can get you broke because I admit there are instances when it can work towards a zero account balance. Basically, leverage allows you to control a larger position. You could say that your broker loans you some money to trade: if you are trading with 1:100 leverage, it means that for every $1, you can control $100 (… somebody please tell me why this is bad). But this also means that when you lose, you lose more because your trade was leveraged. That’s perfectly normal, because brokers are not charity houses and it would be totally weird for them to say “Oh, you lost… poor boy… we will cover your loss”. So let’s simplify it a bit: leverage can increase your profits and your losses. This takes us to the next issue: your personality. Do you like to gamble and take big risks? If that’s a yes, then leverage can work against you because it will bring out the gambler in you: knowing that you have such a powerful tool at your disposal can make you increase position size to make up for lost trades; if you continue losing when you are trading with high leverage… well, I don’t have to explain what will happen. On the other hand, if you are a guy who doesn’t get too emotional when you lose and you can keep calm, leverage probably won’t hurt you much.

 

Going back to “leverage can increase your profits and your losses”, let’s think about something: are you a good trader? Do you win more than you lose? Assuming you win at least 51% of all your trades, how can leverage hurt you? If every trade can win or lose one buck, in 100 trades you will lose 49 bucks and win 51, bringing your net profit to a tremendous $2. Ok, but if – with the use of high leverage – each trade can win or lose a thousand dollars, where do you stand? Oh, now you have a net profit of $2000… much better I’d say. If your trading is good and your state of mind is as it should be, leverage alone cannot get you broke, but if your trading is all over the place, you are emotional and try to make up for lost money by increasing the position size, leverage can be hazardous to your account.

 

Bottom Line – Guns Don’t Kill People

Yes, guns don’t kill people. People kill people. A gun in the hands of a well trained and sane policeman is an instrument which will help him enforce the law and protect us and our families. The gun is used wisely and it brings benefits. But a gun will kill people if it’s used by a murder…. Who’s to blame then, the gun or the person who kills? The answer is obvious in my opinion. Now think about leverage the same way: it’s just a tool which can be used the right way or the wrong way and it all comes down to who you are and how you trade. Are you the policeman or the thug?

 

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