Trading with Leverage | How Much Leverage Should You Use?

A Question About Trading with Leverage

stock trading mentorQuestion:

Hi Pete

According to you, which is better:

mass profit with a potential for mass destruction (in my case, 2% risk per trade with a 10 point stop loss)

or moderate profit with a potential for moderate destruction (e.g., 0.2% risk per trade with a 10 point stop loss)?

I ask this question because I wouldn’t hesitate to use leverage if the risk for a massive draw down in a single trade weren’t existent.

How to Trade with Leverage

Answer:

This is a great question.

The answer must be addressed in the context of the quality of the idea.

Many books will teach a generic formula for risk but the fact of the matter is some trades have higher probability.

Your job as a developing trader is to identify when probability is higher or lower and adjust your leverage accordingly.

Think about Real Estate. If you have a great property in a great neighborhood with great profit potential you would have no problem borrowing more money to finance the deal.

Trading is the same way.

I am not saying to deviate from your 2% often but sometimes the charts line up perfectly and opportunity is greater.

Great traders simply trade bigger on better ideas.

A key to remember is this does not mean you go β€œall in” on your initial entry.

You can work the beginning of a trade and add as it proves itself.

Being aggressive can also mean, multiple positions and holding trades longer.

Pete

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Leave a Reply 27 comments

bob curran Reply

pete, having lost 400k + , seen many,many people and their systems and lost money ,, chat rooms,,,,,so pete iam at the point where i need to see results,, baby steps ,into a trading world where the winners are larger than my losers, iam looking forward to see your methodology of trading success ,thnx ,bob

    pete renzulli Reply

    Hi Bob
    thanks so much for writing
    the best advice I can give you is to choose one strategy with small size and get proof it works.
    Three months of flawless execution. Inconsistency usually comes from lack of commitment.
    Let me know if you need help.
    Pete

Passion4Trading Reply

There is a fundamental problem related to statistics Pete that makes what you are suggesting extremely risky…and can completely skew performance metrics…not to mention potentially subjecting ANY TRADER –pro or novice– violation of RISK TOLERANCE LEVEL acceptance…that can have serious psychological implications aside from financial implications. RANDOM DISTRIBUTION…and UNCERTAINTY IN EACH & EVERY TRADE–which trump even the highest of odds setups.

    pete renzulli Reply

    you are confusing probability with risk management. It makes your point out of context.
    Come on you’re better than that!

    You can’t get on the Long Island Expressway and do 75mph and not expect to make adjustments.

      Passion4Trading Reply

      Of course–adjustments should ALWAYS be part of one’s plan. But I believe context actually does indeed apply here–because “using leverage” in essence implies that one would take a significantly higher higher $ loss than normal–should a rapid deterioration against one’s thesis take place prior to the time it took to make an “adjustment” upon recognition of the issue-and full stop loss occurs. These are the black swan scenarios–that although highly improbable—are indeed very real–and as mentioned–can have catastrophic consequences to mindset as well as finances. In most cases–yes–astute traders upon subtle signals will have time to adjust–but one needs to at least be aware it is also subjecting one to unforseen events that can be easily avoided by keeping accceptable risk constant always–w/o taking away potential for huge R multiple returns–and w/o taking away from ability to adjust for less than 1R losses in most cases.

      But hey–we can resoectfully “agree to disagree” on this subject!

Passion4Trading Reply

This undisputable mathematical concept will subject a trader to the risk that a much larger loss can occur despite odds being high…while at the same time including within performance winning trades that potentially have lower odds that end up with large R ratio return–yet smallest risk was put on. In the end–this will comepletely skew the most reliable performancd metric out there–EXPECTANCY. Therefore–this begs a question– Why would we risk any amount of $ in first place on low odds (B & C setups)? Instead– why not risk $ ONLY ON A+ SETUPS…OTHERWISE SIT ON HANDS? By doing this–and risking a fixed R WITHIN ONE’S ACCEPTED RISK TOLERANCE ON EACH & EVERY TRADE–we ensure odds are always in our favor–yet at same time prepared for uncertainty & random distribution as well. The only variable would be how a trade is managed to maximize potential for large multiple R return.

    pete renzulli Reply

    Your theory is correct but very few traders accept a dollar amount and simply let the trade play out. Very few traders say “I am losing $X on this trade and I am sticking to it no matter what” I have managed traders for ten years and it is never as black and white as you are implying. (although the work you are referencing is excellent)

Passion4Trading Reply

The net net is a system that has winners consistently outsizing losers–without the financial & emotional risk that can come from “pressing” or “going with size” (which means much larger loss if wrong).

Pete–all it takes is a few bad trades that were A+ to go bad to have catastrophic results that many may not be able to overcome. I welcone constructive rebuttal–but this argument is very difficult to overcome–because math & statistics do not lie. To understimate their affects sets one up for disaster…so why should we ever go there in first place? Taleb & black swans come to mind?

    pete renzulli Reply

    You are implying once a trader puts more leverage onto an A+ they would simply close their eyes and lose more money. Stop that.
    Point # 2 is you can’t make $1,000 on a $5,000 idea.

Passion4Trading Reply

From a devil’s advocate standpoint–it may come to mind–“Why not just ensure that risk tolerance is still covered when going in with size when appropriate…that way–if wrong…one will still be within acceptable $ loss?” Problem is–this again means by definition u will be throwing less $ at LOWER ODDS TRADES—yet we should only be trading when odds are om our side….so therefore they CANT POSSIBLY BE IN OUR FAVOR IF WE ARE NOT WILLING TO TRADE OUR MAX RISK TOLERANCE LOSS PER TRADE! Vegas does not take a single bet with odds not in their favor–NEVER. So why should we?

    pete renzulli Reply

    You hit the nail on the head. Too many traders never understand the core goal is for all of your losing trades to be on great ideas. You worded it perfectly “throwing money at lesser odds trades.”

    This is a HUGE problem for many traders. Lowering share size DOES NOT decrease the risk or increase the odds! Short-selling a strong stock with less shares is not lowering risk. It is still a bad idea.
    Great point.

Passion4Trading Reply

Instead–depending on market conditions–while our $ risk is always static–how we manage trade will determine our potential return odds (ie wide stop trail if long in strong market w/ sector wind & no supply/resistance in sight in stock or SPY in strong relative strength equity…which indicate high odds for follow thru & large R multiple return… or tight trail or limit out/book profits when long & stock and/or market hit supply and/or deteriorating conditions/weakness etc set in…which would indicate low follow thru odds & therefore lower R multiple expectations as examples). These are all things that we NEVER know until in the trade (ie –now we have more information which adds or subtracts our odds that existed at entry)therefore we dynamically adjust as needed–again–all the while ALWAYS WITHIN MAX RISK TOLERANCE.

Pete–as u can see Im passionate lol–u were a great inspiration to me at T3…many of my principles/rules/strategies are byproducts of some element of wisdom or nugget u conveyed. THANK YOU πŸ™‚

    pete renzulli Reply

    Lou your passion is awesome. πŸ™‚

Tarek Reply

I have been actively trading for 3 years so far. I did great mistakes, the conclusion of those mistakes was putting trades that bigger than my account size.
However, leverage is good tool to use it only under the size of your account, and in many different trades that has higher probabilistic. On other words, implement many small trades so if it lost the other winners would make it up.
I used my leverge in future trades like /CL , so mini which were way bigger than my account size and of course I got margin call. Since than I learn the big lesson in tradeing in small size trade that if I lost won’t impact the size of my account and do many of those trade, only when you see the high probability pattern.
keep your trade small, and don’t get fool by the leverage, keep it very small like you going to put 100 of them all depends on your comfort with the size of the trade, be ready to lose it all and still able to countiunue the journy because you will lose some.

    pete renzulli Reply

    Very good points.

    Passion4Trading Reply

    Tarek–great example of how leverage can be used without exposing one to a higher than normal loss.

    One point– try not to think in terms of “small”…as that is a relative term–and can be perceived differently by others.

    The best descriptor is trade “within one’s risk TOLERANCE LEVEL PER TRADE”. This should mean the SAME THING FOR ALL—that being:

    “An acceptable $ amount at risk/trade that will not negatively impact one emotionally/psychologically…as well as will not have material impact on one’s trading account.” (Research ‘risk of ruin’ to determine based on account size & risk size what is acceptable to u)

Daniel Reply

Hi everyone

My question was indeed asked in the context of a black swan event.

But Pete’s example of Real Estate enlightened me on the subject of trading mastery. A master trader never worries for going bankrupt in such an event because he knows (and his lenders too) that he can rise like a phoenix from its ashes, like Jesse Livermore did several times in his life (excuse me if I seem pompous). Pete gave me an important clue to the answer I was searching for, namely that the greatest (whom we should strive to become) don’t worry for big losses independent from their will, because they hold the key to unlock the riches at any moment. Now let’s get to work lol.

    Passion4Trading Reply

    Daniel,

    Pete said:

    “Think about Real Estate. If you have a great property in a great neighborhood with great profit potential you would have no problem borrowing more money to finance the deal.”

    Be very very careful here–as it is a very slippery slope to put too much emphasis on our perceived abilities.

    Black swan’s can easily trump the greatest of greats if the material impact from them are disregarded.

    Since real estate analogy caught your attention–let’s think about that and black swans.

    The exact scenario Pete described actually took place—day in…day out…for an extended period of time at that–with investors/flippers making a killing–under the perception that “cant lose –great real estate ALWAYS appreciates”. Then one day- POP–the bubble burst—and many were left holding the bag-thinking “this could never happen to me”. But yet–here they were–forced to foreclose & take mass devastating losses -DUE TO BLACK SWAN EVENT NEVER BEFORE SEEN IN OUR LIFETIMES.

    Do u seriously want to put yourself in that POTENTIAL position…EVER?

      Passion4Trading Reply

      Daniel,

      A very important thing to understand here—

      Humility is the best virtue u can have in this biz.

      There is no room for pride and ego in trading–as these are the most common traits present often when risk tolerance levels are violated and risk is disrespected and excess risk underestimated.

      I am giving u the best advice out there–relying on our pereceived abilities to bounce back is recipe for disaster.

      And keep in mind- I dont believe for a second this is what Pete was trying to imply by bringing up the real estate example.

      Good luck to you!

        Daniel Reply

        Once again, my question was raised over a problem of fear of being caught one day in a black swan event…
        I think Pete in his real estate example was talking about using more leverage on a good probability trade, and I pushed his metaphore a little further!! I was implying that his example gave me the confidence to trade with 2% instead of shrinking the size of my trades to 2%.

          Daniel Reply

          shrinking to 0.2%. Sorry.

      Daniel Reply

      No, indeed, that was why I was asking my question in the first place. I was not talking about increasing leverage beyond 2%, but about decreasing leverage to, e.g., 0.2% to be able to sustain a “moderate destruction” of equity in the case of being caught in a krach. Sorry if my question wasn’t clear in the end.

      pete renzulli Reply

      a trader will never be successful fearing a black swan event. You will always trade scared.

        Don C. Reply

        On that note, prepare for the black swan. Trade your regular position, but why not set up out of the money options on either side to hedge against the black swan? Just my thought.

          pete renzulli Reply

          pretty solid idea. Options trading is a whole separate conversation. A completely different business from directional trades

Don C. Reply

I think it’s fine to pyramid into winning trades. There’s no question that this involves more risk but you have to make a decision on why/what you are trading for. At some point in time most hugely successful traders have blown up their own account, someone else’s account – or both. I have found that no matter what you are trading, at some point the “stars” line up and you gotta go big.

    pete renzulli Reply

    Hey Don
    Great to hear from you!

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