DislikedSo let's say I open a forex position with $100 (that's ALL I have in my account) and I now control $10,000 worth of currency. What is the leverage?
Now let's say I tell you this over a beer: "Hey Faure, you know what, I have $10,000 dollars just sitting and collecting dust in ANOTHER forex account with ANOTHER forex broker".
Now you mean to tell me that NOW my leverage is not 100:1 ANYMORE but 1:1 simply because I told you that I have $10,000 somewhere else ??? Come on! What if I tell you that I lied, that the $10,000 is in the cookie jar in my kitchen instead, am I still trading with 1:1 leverage according to you?
Leverage has NOTHING to do with your trading balance, nothing! It simply means how much money you can control with X amount of money, period. How much money you have in your FX account, your bank account, your mattress or your attic has nothing to do with leverage, nothing.
This is what FX is all about: "Give me $100 and I will let you own $10,000 worth of currency (100:1 leverage)". How much money is ALREADY in your FX account or how much money you INTEND to wire to your FX account each week/month is totally irrelevant.Ignored
How much leverage should you use?
Maximizing growth without risking bankruptcy
Many hedge fund disasters come not from making the wrong bets – that happen to the best of us – but from making too big a bet by overleveraging. On the other hand, without using leverage (i.e. borrowing on margin to buy stocks), we often cannot realize the full growth potential of our investment strategy. So how much leverage should you use?
Surprisingly, the answer is well-known, but little practiced. It is called the Kelly criterion, named after a mathematician at Bell Labs. The leverage f is defined as the ratio of the size of your portfolio to your equity. Kelly criterion says: f should equal the expected excess return of the strategy divided by the expected variance of the excess return, or
f = (m-r)/s2
(The excess return being the return m minus the risk-free rate r.)
This quantity f looks like the familiar Sharpe ratio, but it is not, since the denominator is s2, not s as in the Sharpe ratio. However, if you can estimate the Sharpe ratio, say, from some backtest results of a strategy, you can also estimate f just as easily. Suppose I have a strategy with expected return of 12% over a period with risk-free rate being 4%. Also, let’s say the expected Sharpe ratio is 1. It is easy to calculate f, which comes out to be 12.5.
This is a shocking number. This is telling you that for this strategy, you should be leveraging your equity 12.5 times! If you have $100,000 in cash to invest, and if you really believe the expected values of your returns and Sharpe ratio, you should borrow money to trade a $1.2 million portfolio!
Man who scratches ass should not bite fingernails