Relationship of leverage and drawdown

[Mike805]

Quote from alexandermerwe:

Let's try to clarify things because I think you misunderstand and/or using words in a different context that everyone else uses them.

Let's say you have 100k cash and 10 stock trades in the year. You buy 1000 shares and you make $1 profit in each trade. You make $1000 on each trade and your return at the end of the year is 10%.

Now, should your broker increase your leverage from let's say 2x to 4x or 8x or 10x your return will not be affected UNLESS you increase the number of shares.

You should NOT calculate your return on the leveraged capital but only on the cash portion of the capital. The loan offered from the broker is NOT your capital, it's just that, a loan to increase your purchasing power.

Now, if 5 trades in a row in the above example lost $1 after you made 5 consecutive wins, your drawdown is 5K and this is not affected neither in magnitude not in duration UNLESS you increase the number of shares you buy long in each trade after you increase the leverage.

Annual return is calculated on the cash portion of the account and increased leverage does not affect return unless you also change your position size.

Yes, this is what I'm talking about, returns on cash in the account using whatever leverage size.

Your points about position size are trivial... You need to do the math and you'll see that 2x leverage does not double both drawdown and return on the CASH balance. The first post I posted in this thread shows this using a normal trade distribution. Do some research on how annual returns are calculated and then run the numbers, I think you'll see what I am saying.

Mike

 

[Trader2538]

Quote from alexandermerwe:


You should NOT calculate your return on the leveraged capital but only on the cash portion of the capital...

Annual return is calculated on the cash portion of the account and increased leverage does not affect return unless you also change your position size.

I agree with these points from Alex.

More leverage would likely change the system or style of trading, so that returns are less volatile. For instance, to keep drawdowns minimal, you would not necessarily use extra leverage all of the time. In fact, you can now use 100 shares or smaller size on "riskier" or more "volatile" trades/executions.

More leverage adds to your account by increasing the volatility of more nuanced moves. A five-cent move on 1000 shares or 10x share size is now a much greater change in P/L. And a 5-cent move with 100 shares or 1x is negligible.

So leverage can also mean an adjustment in risk management, also known as adjusting one's "system" to fit the cash deposit/account size, and leverage or margin available.