When to go for leverage trading and what are key things to keep in mind? – Economic Times

A trader should always take the concept of leverage very seriously, because being overleveraged can present significant risks, while if you choose to stay underleveraged, it may minimise your earnings potential.

Leverage must be used only within its logical limits, as its effect on both gains and losses can get magnified. A trader should use leverage only when the advantage is crystal clear on her side. Trading volume in the market is an equally important factor to take note of while using leverage.

Leverage is a facility offered by a broker or financial intermediary to a trader to allow him to take positions bigger than what he can do with the collateral balance in his account. As it offers greater market exposure to the trader, this can work as a double-edged sword.

When used properly, leverage can be a game-changer. High leverage can be attractive, but is very risky. Options trading, futures contracts and buying on margins are all examples of leverage trading.

A highly-leveraged trade can quickly deplete your trading account if it goes against you. The greater the amount of leverage on the capital you apply, the higher the risk you will take for yourself. So, it is important to track the positions, apply stop loss and use other market orders to prevent large-scale losses. As always, traders need to keep their emotions under control in this area.

Sticking to a trading plan and constant analysis of mistakes are important. One should design a strategy for each trade. Position size is key to keeping the overall trading risk under control. One should not take a position without first establishing the reward-to-risk possibilities. One should understand the risk associated with a trade and one’s risk appetite before deciding on the size of leverage to use. Once the risk in terms of the number is known, it is possible to determine the potential loss of capital. And trader should not take losses in excess of 1-2 per cent of capital in a single trade.

(DK Aggarwal is Chairman and MD of SMC Investments and Advisors)