Leveraging - Learning the basics
Here's a wonderful article by Deepak Shenoy:
Explains in simple, lucid terms about:
- The meaning of leverage
- Opportunities that come due to leveraging
- Dangers that can occur due to leveraging
Very well written article. Absolutely easy to understand.
The only things that could have been added to the above article are:
- Extending the concept of leveraging to stock market and commodities market through:
- Margin-based day-trading
- Playing in the derivatives segment - Futures & Options
- What kind of individuals should indulge in leveraging? Under what circumstances? To what extent?
My own take:
- Nobody other than professional traders with rich experience should indulge in leveraging - they should restrict their area of operation to long-term investing.
- Even professional traders should learn enough about asset allocation, money management, behavioural finance, operation of stop-losses, etc. before leveraging.
- Even then, they should start really small, allocating a "trial based" sum of money to "learn the tricks of the trade"
- Most importantly, those who indulge in leveraging, should continue to do so, only if they are able to develop a trading strategy and actually execute the strategy - Many of them end up burning their fingers by their own inability to actually execute the strategy. For instance, even if you have an excellent strategy involving a "stop-loss" to be triggered when your losses reach a particular level, it simply can't work if you change your stance midway and fail to cut the losses at the appropriate time.
- We should understand that there is a role for a Sehwag, a role for a Dravid and a role for a Harbajan. If any of them starts trying to imitate either of the other two, the result would be disasterous. In a similar vein, we should understand our own individual style of investing and stick to that.
Take care. Be cautious. Make money.