Lessons from Dubai on risk
Over the course of this last week I have been writing from Dubai as I have been leading an FX trading course for aspiring traders. Needless to say, one of the key teaching aspects I have been emphasising is the danger of using leverage and that has led me to that theme for some of my posts during this week.
Understanding the impact of leverage on risk management
The first benefit of deleveraging your trading
Today, before my flight home to the UK, I was able to visit the Burj Khalifa. The World's tallest building. It was quite something and the views over Dubai were stunning. The Berj Khalifa stands at 828 metres and was completed in 2010. Considering the effort that went into the construction of the project it is interesting to note that the Berj Khalifa only stands so tall, because it's foundations run so deep. Here are the photos that show the first two years of construction. In these records it shows that the tower didn't even get off the ground in the first two years.
2004 and excavations began
2005 and still at ground level, 2 years into the 6 year project (2004-2010)
It was all about building solid, deep foundations. In a similar way, trading without leverage can seem like slow progress. Where is the fun? The buzz? How can I make money? The truth is that by putting in solid stable risk management you are preparing yourself for real, serious growth. You are putting in the ground work necessary to be a responsible risk taker. Remember yesterday's article here. Today's article highlights the mental relief of trading without leverage.
Trade in a calm frame of mind
The second benefit of deleveraging your account is that it allows a professional trader to think calmly and logically. One of the major impacts of using leverage is that it is very hard to think unemotionally when you are risking large percentages of your account. A certain aspect of successful trading requires a detachment from a trade and not over managing it. If you are using high levels of leverage then you will find it much harder to keep an emotional detachment to your trades. You are far more likely to intervene and mis-manage a trade. Using leverage also makes you vulnerable to a black swan event when huge moves can happen in the currency market. In 2015 the EUR/CHF fell around 40% in just a few minutes when the Swiss National Bank gave up defending it's 1.2000 peg. Just a couple of days before this the SNB had outlined their intention to keep defending the peg. If you were trading leveraged during this even you would have risked losing all of your account in a few minutes. People as large as hedgefunds and small as retail traders were all vulnerable to being wiped out during that event. Some of these people lost their entire trading capital by this event. Not nice.
When you will use leverage
Now you can use leverage, but only when they have the highest conviction in a trade. For example, when a central bank surprises the market and hikes interest rates. That would exactly be the time that leverage would be used. However, they will have a very definite plan of where to exit should the trade not play out as they expected. An example can be seen in the chart below when the Bank of Canada surprised markets on the 12th of July in 2017 by raising interest rates (CAD positive). The pair below is USD/CAD and it fell heavily (CAD being bought) with the surprise hike. Over the next 10 or so trading days price moved over 300 points with very little retracement. This would be an excellent scenario to use leverage to maximise your gains as traders would have the highest conviction that the trade will move in their direction.
In conclusion
The Burj Khalifa was built on strong stable foundations. Your trading, whether it is a hobby that pays, or you aspire to manage a fund, or maybe to even manage family capital will only prosper when you master risk management. A deleveraged account is a fundamental step to controlling risk. If you are reading this and the articles over the last few days have resonated with you then step up and take repsonsibility, so that you can carry on taking risk in a measured and calm way. It makes for a much calmer trading experience. Oh, and by the way, the view from the top will all be worth it in the end. Herein endeth the lesson...
