The problem faced by most traders is overleveraging, which can bring huge losses. It occurs when one over-borrows to open positions that are oversized in relation to what can be reasonably managed. This could lead to acute financial strain and might eventually blow a trading account.
The new trading landscape and all the higher leverage options come with highly risky financial instruments, so getting overextended is easier than ever. MetaTrader 4 is an incredibly powerful trading platform that can increase risks if not used wisely.
Effective risk management is the path to avoiding overleveraging. Tools such as the Risk Manager EA can greatly help in managing exposure, hence avoiding cases of overextension. Proper understanding and application while applying a proper use of leverage can save a trader’s accounts a lot and guarantee the long-term existence of their trading.
What Is Overleveraging?
It’s overleveraging when traders take on more risk than they can handle by borrowing too much money or maintaining excessive leverage. This can be the case in any market, from forex to equities to real estate. In trading specifically, using leverage catapults position sizes beyond what one’s account balance can safely support.
The Dangers of Overleveraging?
Overleveraging can be devastating. For instance, when a trader opens a rather big position on a soon-to-happen, favorable market move and, suddenly, faces a reversal. This easily runs into huge losses as any losses are multiplied by the leverage. Here are some key consequences:
Margin Calls Risk
Any condition wherein your account balance falls below a certain level may result in a margin call, mandating the deposit of more funds to hold one’s position or face liquidation.
Fast Losses
As shared in the video, one wrong move in the market can bring very fast and huge losses, possibly blowing a giant hole in your account.
Psychological Stress
Running overleveraged positions pressures one’s judgment, leading to even poorer decision-making and further losses.
Real-World Examples
Examples of some notable traders who became victims themselves can illustrate the dangers of overleveraging pretty well:
In his book, “Education of a Speculator,” he describes how being gigantic at a USD/JPY short left him exposed to grave losses when the market moved against him. His firm went out of business shortly after that due to overleveraged positions and downturns in the markets.
Bill Hwang is the founder of Archegos Capital who reportedly lost $20 billion in two days due to extremely leveraged swap positions, showcasing how overleveraging begets a suspected financial debacle.
How Not to Overleverage?
Traders should be prepared for and avoid such situations of over-leveraging by putting in place a few key practices:
Proper Leverage Levels
Leverage should never be overused. One needs to understand clearly the leverage ratio one is using. For example, when a person has $5,000 in an account, 20 times leverage then means controlling a $100,000 position. Ensure your leverage is by your risk tolerance and trading strategy.
Implement Effective Risk Management
The risk management tools available can be very helpful in avoiding overleveraging. One of these tools will be the Risk Manager EA, which is extremely useful for its ability to easily be embedded and thus enable smooth use from within MetaTrader 4, ensuring continuous control of leverage and exposure to risk. This is done through the following:
Download and Install
Download the Risk Manager EA from your trading platform’s website then add it to your chart.
Setting the Risk Parameters
Configure the EA to manage your risk by specifying what percentage of your account balance you are willing to risk on every trade. Here, the general advice is not to risk more than 1-3 percent of your free margin per trade.
Monitor and Adjust
The Risk Manager EA keeps track of trading account positions on behalf of a user. Leverage and risk levels need to be set at predefined levels by the user.
It is important to understand the basics of leverage and its associated risks. Learn how leverage is exercised, how it works, and how to calculate leverage with regard to your particular financial situation. Knowledge is power, so stay well-informed to enable yourself to make better decisions.
Especially as you are just starting out in trading and/or using leverage, keep the size of the positions small. This will allow you to learn and become familiar with the effects of leverage on your trades without losing big money.
Review and Adjust Strategies Regularly
Keep reviewing your trading strategy and leverage usage. This will have to be in line with your trading performance, prevailing market conditions, and changes in your account equity. Continuous evaluation will help ensure that your leverage remains appropriate.
Conclusion
One must take care not to overleverage, for it leads to a sure end of inclusive trading. Proper leverage levels can protect traders from falling into the ditches resulting from too much risk exposure through proper risk management with tools like the Risk Manager EA.
It shouldn’t be forgotten that even though leverage unfolds profit, it also can increase potential losses. Keeping yourself responsible personally for your risk is crucial in staying responsible and taking control into building a long-term successful trading career.
