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Leverage, part 1 – Avoiding the Unavoidable

Leverage, part 1 – Avoiding the Unavoidable
Friday, March 9th, 2007 @ 6:49 am by Mihai Marinescu

The first thing a rookie learns about leverage is: a trader cannot do without it.

It is a sort of necessary evil, a big bad wolf that keeps showing up…. The higher you set your leverage, the higher your risk – but still, unless you use it, you cannot make good profit. Tricky…

Even if everyone is talking about leverage and almost everyone believes to have understood how it works, there are still so many misconceptions about this concept that cause traders to lose money.

We will start by analyzing together two of the most common misconceptions about leverage, and point out how a half-truth can turn into a big fat lie, when our emotions and greed decide to take over.

The first myth that I have in mind starts from the common assumption that “one cannot trade without leverage”.

Put it another way:

  • “I have no time to waste, I know what I’m doing so I’ll use the highest leverage available and make some REAL money!”
  • “The higher the leverage, the higher the probability of success.”
  • …and so on

There are many ways to say this, and they all praise the virtues of leverage, which over night turns into a trader’s best friend (of course, after the trend). We are talking of course about a false myth, and in what follows we will see why. Moreover, we will see how much damage this way of thinking can do to a trader, and what is the probable consequence of highly leveraging one’s trades.The second myth we will put on the table is somehow opposed to the first.

Actually, it is a myth created by those who finally understood the danger of believing in the ultimate power of leverage. So, they take an extreme, opposite position: set their trading platform on the lowest possible leverage, and trade the same way as before.

Our big bad wolf is again on the prowl… While trying to be careful, these traders put themselves in an equally dangerous position. We will analyze this situation in detail, and see why understanding all the meanings of the word “leverage” is so overwhelmingly important when trading on Forex.

To be continued…

One Response to “Leverage, part 1 – Avoiding the Unavoidable”

  1. tradingfan says:

    hi there, i was looking for the similar kind of information and i found that on your blog. Thanks for this information.

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