Is Using Leverage a Good Idea?

 This is an e-mail conversation that Trader Scott had with one of our great readers. It may be helpful:

Q:  Signed up with a new broker the other day…. and holy cowbells!! Amazing, for me at least. I can short, use CFD, Options (but seemingly not on NYSE yet…grr. I wanted to be able to do options on first majestic), bonds, investment funds, bunch of ETFs I can’t trade without commission, and stuff I had never heard of before let “sprinters” and “warrant shorts” with crazy leverage ratios. Holding multiple currencies in the account. They even let me go 100% over the value of my own assets with them with a few clicks of the mouse, and the trading fees are literally 5x less than other services. Seriously, its making my head spin the stuff I can do. And yet, apparently this is the first service for Europe that rivals what investors over in your neck of the woods could do already :). Still, I am amazed.

A: So lots of ways to get creamed. Seriously tho – I’m scared to death of debt/leverage. But, as a trader you have to be honest with yourself, know your weaknesses and then figure out how to diffuse them. I use that to my advantage with leverage. I only use it with very short term trading. It “forces” me to understand and RESPECT that I’m highly leveraged and at great RISK. So, then I’m much more focused and I know that I can’t sit on my rear – so I need to be quick to take profits (or losses).

Q: Huh, thanks for your thoughts on that! I was thinking of only going into significant debt for quick movements, e.g. into an s&p 500 leveraged short “sprinter” if they do decide to raise rates on Wednesday, and then only for a day or so. But I’ll be careful!! Still need to move my assets over to this broker anyway, and other brokers tend to make that hard to do…

 A: Please only short into STRENGTH. I will not dissuade you in any way, but if it were myself in the scenario that you laid out, I would use the ensuing rally after the initial selloff to get short. Those stupid news-related days are usually very volatile.

 Q: Huh, you know I am not sure I fully understand this! Stupid news related story comes out, people panic and it causes a selloff in the markets. The markets either rebound back, and return to low volatile range trading, or the sell-off intensifies. If it rebounds back up, why would I think that it might crash down again afterwards – unless it magically rebounds back to make new highs, with the market over-extending itself? My idea is basically to be at the front of the queue with this news story, since I “think” I can say with reasonable certainty how the markets will react either way, either shorting the S&P or going into JNUG if they don’t raise rates. At least, I am certain that metals will see a rebound if rates are not raised, but do you think the markets will do anything other than panic if they do?? You have much more experience here than me obviously, so I respect your opinion on this!

A: It took me a long time to understand this: My job as a trader, especially very short term, is not to guess what’s going to happen. My job is to be fully prepared and to be able to anticipate, not to react. Don’t do what everyone else is doing. Take the opposite side. Most folks try to “guess” what’s going to happen and/or react to what just happened. My job is to WAIT/ANTICIPATE for the LOWEST RISK/HIGHEST PROBABILITY ENTRY POINTS and then IF that opportunity/situation that I have already planned for and anticipated does arise, then to have the guts to ACT/NOT REACT into those volatile, powerful lows and highs in the market. I do NOT spend time trying to “guess” what is going to happen. That’s not a winning strategy. Until I learned how to approach markets in this manner, I kept having great trades, but wasn’t able to keep those profits. Of course, on any individual trade, one can “guess” correctly. But over time, we’ll get destroyed with that approach. It’s in the waiting for those ENTRY points where you will begin to blow yourself away with your profitability and high trade success rate. Wait for the setups. Be patient. Watch the bottoming and topping processes unfold – on any time frame. And pounce when YOUR opportunity arises. And I’m not saying that your current plan won’t be a success in this particular situation that you have laid out. I’m telling you from doing this thousands of times the way that made me successful. And as to a known upcoming news event, if the market is “telling” me what it wants to do, I won’t hesitate to have a position on into that event, like with Brexit. I actually, right into the vote, thought that it would be a stay result. But the 2 days leading up to the vote the market “told” me to short into that rally. And I covered half of that short (FEZ) into the fear at the open of markets the following Monday. It’s just trading, not trying to figure out. I’ve lost a lot of money trying to figure things. I’m trying to save you guys from my stupid mistakes.
So does this make sense?
 

Q: Good stuff! I guess there is one thing I don’t fully grasp yet though, re what the markets are signalling to you. Say pre-Brexit, what was it you were looking for then?
 

A: There are a lot of things about markets that I don’t fully grasp yet, so relax about that issue. But to answer – that just gets into the boring stuff about my method that I use with markets. There was suddenly a surge in bearish SUPPLY that kept piling on to stocks at the top of all of the intraday rallies over the last 2 days into the vote. I told a buddy of mine that I don’t know what happened all of a sudden, because I assumed/GUESSED that the vote would be stay, therefore (supposedly) bullish for stocks. But I told him that I am going to have to get short. He said he saw the same thing. Did the “manipulators” know something, I don’t know. But I have learned that I need to follow thru on what my work/method “tells” me. Right or wrong, that’s all I know to do – to follow my gut/instincts/preparation/ experience, whatever it actually is.