Day trading is a business and the point of a business is to make money. One way to make more money in day trading is to use leverage. When leverage is used in a disciplined manner it can be an effective tool. What is important for the novice day trader to realize is that while using leverage increases one’s potential profits it also magnifies potential losses. If a day trader is going to use leverage in his or her trading it is important to understand how it works as well as ways to manage associated risks. When used correctly there are advantages to using leverage in day trading.
Understanding Leverage in Day Trading: A Beginner’s Guide
Leverage in day trading is when one uses borrowed money when trading futures, foreign currencies, or stocks. By borrowing capital with which to day trade one can multiply their gains in relation to the amount of their own money they use in each day trade. This works to the extent that one’s return on the sum of all trades during a session exceeds the cost of using borrowed money. If one’s trades for a series of sessions result in substantial profits and the only expense is the cost of borrowing the capital, this approach can multiply one’s income. However, if the day trader runs up losses over several sessions they still owe their broker for money borrowed. When leverage is not used with the appropriate preparation and discipline it can result in losses in excess of one’s original trading capital and personal financial disaster.
The Advantages of Using Leverage in Day Trading
There are often situations in the markets where the fluctuations one can reasonably expect from an asset are quite small. One can be routinely successful in placing day trades and still make only tiny profits. This can be one of the situations where using leverage in day trading can make sense. A wise day trader should do a bit of research into such potential trading opportunities to make sure that there is little potential for the bottom to fall out of a market with destructive consequences. And they should always set stop-loss and take profit targets. Nevertheless, in the right circumstances, using leverage to increase profits when one has established a strategy that is successful can be amply rewarding.
Risks and Drawbacks of Leveraged Day Trading
Risk and reward go together in life like night and day. The more that a novice day trader thinks he or she is going to hit a home run in their trading and maximizes their use of leverage the greater their risk of not only losing all of their trading capital but incurring losses that result in personal financial ruin. Specifically, the risks are that one does not closely follow their trade in an active market, reset stop-loss and take profit targets, and exit trades with reasonable profits. Greed takes over and the day trader remains in a trade until an illiquid market corrects rapidly and abruptly. At DayTradeSafe we teach discipline in entering, managing, and exiting all trades. The more leverage you use the more this approach has to apply.
Effective Strategies for Leveraged Day Trading Success
There may be times when one can routinely profit by day trading a given asset under very clearly defined conditions. A day trader may find that by careful planning and steady discipline they almost always profit in such circumstances. In these cases a day trader may consider using leverage by borrowing a portion of the capital necessary to place a trade. When experience shows that such clearly defined trades carry little downside risk, this can be a routinely profitable approach. It is important to keep careful track of your trades in such cases, not leave positions unattended, and to always set stop-loss and take profit targets on all trades.
Top Tips for Managing Risk When Trading with Leverage
A good rule to start with in day trading in general and especially when using leverage is never to trade with money that you cannot afford to lose. Excessive use of leverage can get to be like “doubling down” at a casino in the mistaken assumption that eventually one big win will redeem all of your losses. In the real world of day trading it does not work that way. The way trading with leverage works is like with all day trading. Never risk your own money until you have done enough simulation trading to routinely make “paper profits.” Always use discipline in following an established and successful trading strategy. Only enter day trades with strategies that you understand. And always treat day trading as a business that needs to generate a sufficient profit to make it worthwhile.