Forex Trading Tips: Lever Factor

Lever Factor

Sheik Zaid road -- the main artery of Dubai is dotted on both sides with skyscraper hotels, modern office buildings and luxury condominiums of fifty stories or higher. To an American it looks much like any twelve lane highway in Orange County transplanted into New York or downtown Los Angeles and save for a few mosques that pop up occasionally in your window view you could easily imagine yourself driving through sunny California but with much better, more intresting architecture.

However, on Thursday night, which is the start of the weekend in Moslem world, Sheik Zaid road turns into an impromptu Indianapolis 500 as the well heeled young men of Dubai start to drag race each other on the main in the latest models of BMW Porsche and Mercedes. As they dart in and out of traffic reaching speeds of 100 miles per hour or more, breaks screech and near crashes occur by the minute.

The no nonsense UAE government is now trying to clamp down on this behavior with police putting locals in jail and deporting expats on the spot if they are caught breaking the speed laws in this manner. Watching this dangerous idiocy unfold before my eyes I find myself in total agreement with these draconian measures because the potential for vehicular homicide seems almost assured if this activity goes unchecked.

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As we continue driving down Sheik Said I also begin to realize that these high speed racing maneuvers are a perfect metaphor for high leveraged trading. At a seminar, a few hours earlier a client asks me what is the single greatest mistake that most currency traders make and without hesitation I tell him – high leverage. Leverage amplifies both wins and losses but what it really does is dramatically reduce the margin of error for each trade. Just as a driver who underestimates his distance has far less time to correct his mistake at 100 miles per hour than he does at ten miles per hour, so does a trader who trades at 100 times leverage has far less opportunity to preserve his capital to versus a trader who trades at only two or three times equity.

Although most professional money managers never trade at more than five times leverage, many retail traders think nothing of levering up by a factor of twenty, thirty even 100 to 1. But consider this fact. At ten times leverage just 5 consecutive losses of 1% will cut your account in half. You would have to double your money from that point on just to get back to even.

The sins of high leverage are preached to retail traders endlessly, but unfortunately they are generally ignored. Nothing makes me less comfortable then getting happy emails from clients after a good trade who tell me that they “really loaded up” on the position. Just as reckless young men of Dubai in their speedy German sports cars, such high leverage traders are an accident waiting to happen.

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