Sunday 24 July 2011

Leveraging - Learning the basics

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.

Regards,

N


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