Understanding Leverage for Funded Trading
Fact: #1 cause of all funded trading failure is over leveraged trades. The highest leverage funded trading program is not your friend, in fact it’s a tool used by brokers and some funded trading firms to persuade you their product is better. In fact they use it so you are less likely to question their other rules. They are dressing a pig in fancy clothes.
More is Not Better
If you have failed a funded trading test previously ask yourself the following questions:
- Do you think 100 is better than 30?
- Did you have less than 20 losing trades?
- Did less than 5 trades represent more than 75% of your trades?
- Did you know exactly how much you were risking on every trade?
If you answered yes to any of these questions you almost certainly have over leveraged your trades and consequently failed your funded trading evaluation.
Over Leverage Trades are a Coin Toss
Over leverage your trades when you click the buy or sell button, you are tossing a coin. Your action is the action of a gambler and not a trader. As with all gambling, it sometimes pays off but the stats are clear: funded traders who continually over-leverage fail. They waste their time and they waste their money.
Account leverage is one of the most misunderstood concepts in trading and this article aims to demystify leverage for funded traders.
Fact: Our 30:1 leverage programs have a pass rate 8-10x higher than FTMO’s 100:1 leverage programs.
What is Trading Leverage?
Leverage is the term used to describe the amount of borrowing offered to a trader by a broker. When a person normally buys a stock as an investment they usually buy without leverage. Let’s say they buy 1000 shares of XYZ Corp at $10, this will cost them $10,000. This trade has no leverage and we’ll call that Leverage of 1. If this company gained 10% the shares would be worth $11 each and the initial investment of $10,000 would now be worth $11,000. A 10% gain for the person.
If the broker offered 2 x Leverage then the same number of shares would still cost $10,000 but the buyer would only need to put up half of this, $5,000, while the broker covers (lends) the balance $5,000. Now when the shares gain 10% and are now worth $11,000, this same $1,000 gain is now a 20% gain on the $5,000 investment.
Let’s now look at these and some higher leverage rates.
We can see from this chart how the amount the trader needs to allocate reduces greatly with the higher leverage and this increases the amount the trader can gain quite dramatically. Wow. Many of you are now salivating and getting excited about finding a 100:1 or even a 500:1 funded trading program. Please think again and read on.
If a 500x trader actually allocated the same amount of money as the investment trader at x1, $10,000. They could buy 500 x more shares, these would have a value of $500,000. And an increase of 10% would make a $50,000 profit. During the trade however, the trader would be borrowing $490,000 from the broker.
If the trade made a 10% loss the trader’s $10,000 would be gone and the broker would be looking to the trader to pay them another $40,000.
Highest Leverage Funded Trading Program – A Double-edged Sword
Leverage is a double-edged sword. The seemingly high gains to be made from using high leverage are very tempting, however losses eat into a trader’s account very quickly and have destroyed many a trader’s dreams of fortunes. And this is what many firm are counting on, and frankly they are right. The numbers don’t lie: Traders on high leveraged account nearly all lose.
High leverage is a broker tool to increase sales and profit. It’s an easy sell, get bigger leverage and earn greater profits – what’s to lose? As it turns out, quite a lot. All data shows that high leverage, especially 100:1 and 500:1 benefits only the broker. Anybody telling you otherwise is either taking an affiliate commission from a broker or is 1. Uneducated 2. Greedy. And as we know greed and funded trading do not sit happily together.
Broker Regulation Changes
Still need convincing? Let’s look at what the European Securities and Markets Authority found when they looked at leverage in 2018 / 2019.
To quote their report:
“As studies by NCAs have shown – consistent with academic research and as also acknowledged by some CFD providers – high leverage causes poor outcomes for investors. This is why ESMA, in its work, has paid particular attention to leverage, as well as other aspects of the marketing, distribution or sale of CFDs. High leverage can be detrimental in three ways. First, because leverage magnifies the costs of investment – such as spreads, commissions or financing charges – relative to margin, at very high leverage investment costs deplete a large share of an investor’s margin. Second, leverage amplifies investor losses and returns. The higher the leverage, the smaller the adverse price movement required to deplete much or all of an investor’s margin. Third, leverage is associated with higher volumes of trading by investors, increasing trading costs via repeated entering and exiting of positions.”
In other words, the higher the leverage the more expensive it is to trade, and the more traders fail.
Regulators in Europe and UK banned all 100:1 and Higher Products
Following this report UK and European Brokers were forced to remove high leverage from their product ranges by the regulators. No more 500:1 or 100:1 leverage. Incidentally, the same report also resulted in the complete banning of ‘binary options’ in trading as pretty much everyone lost money with those). These moves were done by the regulators to protect traders.
Retail traders in the UK and Europe were then immediately hit with heavy advertising and social media drives by brokers from different countries and regulations promoting their “better” 500 and 100 leveraged products, and many traders closed their accounts to open new ones with these higher and “better” leveraged products. Most of these traders continue to lose big sums of money due to the high leverage offered to them. Adam cannot resist Eve’s apple.
Note: US regulators banned high leverage many years ago
How Funded Traded Firms can offer 100:1 and 500:1 Accounts
Funded Trading is NOT a regulated business and therefore funded trading firms can offer leverage at any size they want. What size of leverage they choose to promote depends on their business model and where they get the greatest profit return.
Why some Funded Trading Firms offer 100:1
There are different business models in funded trading and we urge you to investigate each for yourself. The 2 key differentials are whether funded traders are funded in the live market or in demo markets. If the company only places funded traders in the demo market then they are looking to pay the successful traders from the larger pot generated from the fees of the losing traders. If they place them in the real market then they are generating profits to pay the funded trader.
The incentive of each type of firm is reasonably clear. The first is a loser pays model, these wants lots of traders and a very low win rate and the second benefits from successful traders. See this article that explains the difference between FTMO and Funded Trading Plus. FTMO has a win rate of less than 1%.
See here to learn about the difference between Funded Trading Plus and FTMO.
Common Features of Loser Pays Funded Traded Trading Models
Just like brokers did before them, loser pay funded trading firms promote the use of high leverage. They entice Adam to bite the apple and seduce them with 100:1 or even higher leverages and consequently their user failure rates explode. The defence these companies will use is that they are giving traders choice and that they don’t have to use all the leverage available.
We urge traders not to be seduced by this cynical marketing ploy.
High leverage is:
- Bad for your trading.
- You don’t need it.