Currency Trading vs. Casino Gambling

The first aspect of our leverage myth refers to the belief that a high leverage can work in favor of the trader, and even compensate for losses in periods when trading does not give the expected results. A trader that is aware of what leverage can do for him may tend to increase the size of his trades as losses accumulate, hoping for a recovery in the very last moment. This approach can only work against the trader, and usually leads to margin calls and huge losses in trading accounts.

Whenever a trader tries to apply a casino player mentality to trading (on purpose or not), the probability of his success is in fact much lower than if he were gambling in a casino with a 50%/50% chance. The explanations are complex, and we cannot go into details here (our money management courses explain this thoroughly). Still, something is certain: the higher we set the leverage, the more our trading resembles casino betting. And I doubt any serious forex trader would like his results to be a matter of sheer luck…

OK, so why is high leverage dangerous? First, it gives the trader the power to boost his results beyond all reasonable boundaries, making the very idea of a trading plan ridiculous. Why should one try to achieve consistent results when with only ONE, highly leveraged trade, anyone can double his account size overnight? That may of course be true, but the real question is: while it may be possible to do that, how PROBABLE is it?

And, most important, which is the RISK associated to such an approach? We are not talking about a 50% chances of success in this case, but in fact something closer to 20%… Again, I doubt that any trader would confidently go into the market while knowing that the probability of his success is somewhere around 20%… Trading on very high leverage is actually not at all like casino gambling: it is much worse in terms of risk/return!

A few suggestions in this respect:

Carefully consider the size of your account when taking EACH trade and adjust leverage accordingly. This should be a perpetual concern for any trader. Let’s take the example of a trader with 10.000$ in his account. After some brief analysis, he decides to trade with, say, units of 100.000$ (1SL). Let’s say that his strategy tends to produce trades with 100 pips target and 50 pips stop.

Out of his initial balance (10.000$), a first loss would equal 50 X 10 = 500$ (nr. of pips of his stop loss multiplied with the pip value corresponding to a 1 SL position), which is now 5% of his account. He may think that is an acceptable loss (personally I don’t!), and keep going.

However, our trader will take his next trade on a 9500$ account, and he’s not even really aware of that… So, a new loss (of 500$) would now equal 5.25% of his account balance… Similarly, the next loss would reduce his account balance with 5.55%…

This difference from one trade to another goes unnoticed, however for each trade he takes our trader will go against his own initial trading plan: he increases his leverage and increases his risk, without being aware of it. It is less important what will happen next on our trader’s account, as the fact remains: each closed trade (won or lost) brings about a balance modification, which our trader must take into account if he is to be coherent and disciplined with his own strategy. Not to mention that after only 3 lost trades (very possible scenario), he is already down 15% of his trading account!

In our previous example, the trading units remain the same for each trade. Let’s just think about how the risk will increase if the units are doubled for each lost trade, in order to recover the losses… In this case this risk will not simply double each and every time, but in fact be much higher, due to the reasons explained above. It is simply a matter of time until our trader’s balance would reach a margin call limit…

Also, a trader who uses increasingly high leverage often relies (at times subconsciously) on another false myth: that at some point HE MUST BE RIGHT, that he can find, one day, a PERFECT TRADE - where all indicators and trends fall in place - and it will be enough for him to spot this trade and put all his money on it - and profit will come without any doubt. I cannot emphasize enough how wrong such an idea can be… The reasons are manifold, and I hope to get back to this point on some future occasion. For now, let us draw some brief conclusions to this first aspect of our leverage myth.

Leverage is an instrument, NOT a magic wand. Leverage does not spare any trader from learning HOW to trade - a bad trader will continue to be a bad trader regardless of a possibly lucky trade made on high leverage that brought him a temporary big profit. High leverage creates an “everything is possible” illusion, which hides the enormous risk associated to this kind of trading. Experience shows that professionals are the most reluctant to make use of high leverage - and nevertheless it is them who know the market best, making consistent profit out of it…

Reasons? Because for them trading is a business, not a gambling activity. They trade for profit, not for thrills. They understand risk, and want to have it under control at all times. They assume responsibility for both their wins and losses. They don’t need spectacular results achieved over night, but a steady profit that keeps adding up to their accounts. They don’t need high leverage to do that… They choose to educate themselves, improve their strategy and strengthen their skills and discipline. And so should rookies and beginners, if they don’t want to end up fish food.