trading
Finance

Leveraging your capital like a pro trader

Pro traders lose money. Much money. Some months they win, some months they don’t. Most professional traders live off their job because the ups and downs aren’t that much worse than other professions out there (except it is “fun” to talk about your wins with strangers).

It doesn’t matter which type of trades you invest in, whether it’s options trading or futures, you have to learn how to leverage your capital effectively.

How do pro’s leverage?

Pro traders use leverage. They might not call it by its name, but every time a pro trader puts on a trade, he’s thinking about leveraging his capital effectively so he’ll come out ahead in the long term. He may only be up $100 for the month, but if he has $20k in his trading account, then that’s 2%. Compare this to someone who deposits $10k into an interest-bearing account at 1% per annum, who will be up $100 on the year.

Pro traders understand that even though they’re down more over time than they make, overall, they will come out ahead if the average return is higher than what their account sees in margin requirements (essentially interest rates). So if you have $10k in your trading account and an average of 2% return per month, this means you can lose about $200 before hitting your margin requirement of roughly 30% (to keep it simple, let’s say 30%). If that number scares you, don’t trade for a living because that’s how much you’ll lose every month. Some months will be worse; some better, but you’re on track to lose money on average.

On the other hand, if you have $10k in your account and make an average of 2% per month, then you’re able to leverage that money 33x. If you can manage risk effectively, then this is a great way to grow capital fast! Check out the table below:

Scenario AScenario B
$100 * .02 = $2 $100 * .02 = $2
$200 * .02 = $4 $300 * .03 = $9
$300 * .02 = $6     ($9 – 30%) – ($7) =  -$0.70
Total Profit:  $13.70
Initial Capital: $10kInitial Capital: $10k

As you can see, although Scenario A is up more in the end than Scenario B, both traders come out ahead by leveraging their capital. You may ask, “Well, what if they both lost money?” The truth is that pro traders lose all of the time. But it’s not about how much you make; it’s about how much risk you take to make it. If you’re willing to lose $200 every month, then go for it! Just understand that leverage creates exponential returns. The most important thing with using this strategy is knowing your pain point and sticking to/changing it when necessary (traders do this through position sizing).

You might be thinking that if I have $20k in my account and can leverage it 33x, why is it considered less risky only to have $10k? This is because you can diversify your risk by using more instruments/pairs. If all of your money were tied up in one stock or BTC, then all your eggs are in one basket. Even though the trade might work out great, you’re exposing yourself to unnecessary risk if something goes wrong with that one instrument. When you diversify across multiple instruments, your risk decreases.

Using CFDs as leverage

Another way traders use leverage is through contracts for difference (CFDs). They offer no commission per trade, so they’re pretty much pure profit potential most of the time since there aren’t any fees associated with taking a trade. Many traders use CFDs to hedge their bets when they’re in a trade but don’t want to sell an actual instrument to take a short position against.

So what are you waiting for? Start leveraging your capital! And make sure you know your risk tolerance before you start using this strategy. But if you understand the risks, then there’s no reason not to use it because it can accelerate returns massively if done right. Remember, more return, less risk.