How to Avoid Mistake 'Using too much Leverage'? 

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How to Avoid Mistake 'Using too much Leverage'?



The antidote for using too much leverage is referred to as proper "account sizing". Account sizing simply refers to a process whereby a trader attempts to arrive at the "right" amount of leverage for him. The goal is to strike a balance. You want to use enough leverage to be able to generate above average returns without using so much leverage that you expose yourself to too much risk. The ultimate goal of sizing an account is to limit any drawdowns in equity to a percentage amount which will not be so large that it causes you to stop trading. In order to do so you must prepare yourself as much as possible both financially and emotionally for the magnitude of drawdown you are likely to experience using your chosen approach to trading.

There is no one best way to arrive at the "perfect" amount of capital to use to trade a given portfolio. There are, however, several key factors to take into account. The ideal method is to develop a portfolio of markets and trading methods, figure out the proper amount of capital needed to trade each market, and then allocate that much capital into your trading account.

From a practical point of view most traders do not have this luxury and must approach the problem from the other end. In other words, most traders don't say "here is the optimum portfolio and the required amount of capital to trade it so let me just write a check to my broker for this amount." Most traders say "I have x-number of dollars to commit to futures trading. What can I do with it?" If your optimum portfolio requires $50,000 to trade (according to the methods we will discuss in a moment) but you only have $25,000 with which to trade, you must either alter your optimum portfolio or save up another $25,000.

Assuming you are going to trade a diversified portfolio of markets, the first step is to build a test portfolio and look at the historical trading results for each individual market using the trading approach you have selected. What you want to accomplish is to arrive at a reasonable amount of capital to have in your account in order to trade one contract of each market. If possible, you will also want to consider the performance of the portfolio as a whole, to determine if more or less capital is required. In order to obtain the most useful results it is best if you have some method available to generate a trade listing for each market that you intend to trade using the approach you have chosen. It is also helpful to be able to analyze monthly profit and loss data for the portfolio as a whole. If you have actually been trading for a while you may be able to use your past monthly statements to obtain the necessary data.

The Role of Mechanical Trading Systems

There are several benefits to be gained by using a mechanical approach to trading. First, doing so can eliminate a vast array of emotional and psychological issues by virtue of the fact that you are relieved of the burden of having to subjectively make trading decisions on a day-to- day basis. The other key benefit is that by formalizing rules and testing them over past data you can arrive at an objective estimate of the expected risks and rewards. This information can be used to estimate your trading capital requirements. In order to get the most out of the approach to be described you should be using some type of mechanical system for which you can generate either hypothetical or actual trading results, or some combination of the two.

Determining The Amount of Capital Required to Trade One Market

The following discussion is not intended to offer the definitive method for arriving at a proper capital requirement for trading a given portfolio of futures markets. It does, however, address several key factors that should be considered when determining your capital requirements.





Categories in Trading Mistakes

Lack of Trading Plan
Planning plays a key role in the success or failure of any endeavor

Using too much Leverage
Determining the proper capital requirements for trading is a difficult task

Failure to control Risk
Refusing to employ effective risk control measures can ensure your long-term failure

Lack of Discipline
A lack of discipline can destroy even the most talented and best prepared trader

Useful Advices to Beginning Trader
You can control your success or failure

All about Stocks
Encyclopedia about Stocks. That you should know about Stocks before starting

Forex Glossary
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