Determining Leverage For Trading Systems by John Kean
When your trading's going your way, you're apt to think about leveraging your trading based on your success in hindsight. However, leveraging can be a two-edged sword when it comes to profits and drawdowns.
Admit it. Getting rich quick has a certain allure, but pursuing it as a goal seldom pays off. In the world
of trading, fast or instant wealth plans usually involve the use of leverage far and above what is
reasonable. Often, those at risk don't realize what's involved, and they don't realize that overleveraging an
otherwise profitable trading system could ensure eventual losses.
As a first step, let's define the idea of leverage for an individual trader. If you have $100,000 that you are
devoting to trading, then conceptually your trading account has $100,000 of equity. Let's assume this is
money that you "own," not money that you have in some way borrowed. If you entered a position
involving stocks, bonds or futures contracts , with a total entry price of $50,000, then we would say that
you were at a 0.5 leverage. Or say the entry price was $100,000, in which case the leverage would be 1.0.