How leverage can kill your account

Hi everyone. Welcome to this new video. The title today, as you can see, is a little scary. How leverage can kill your account. And the reason why I want to do this video is because I've seen so many people using leverage in the wrong way. And if you do that, the risk is that your account will go to zero. So today I want to show you some of the main reason why this may happen. And by doing that, hopefully you will avoid this mistake. The first thing is what is leverage? Well, leverage means that the broker is giving you money so that you can buy more than what you have. So let's say for example that you have an account of, I don't know, 10k and you have a leverage that is two times. Then you can buy up to 20k worth of shares and it depends on the broker how much leverage you have. Usually for stocks broker you can go to 2, 3, sometimes 4. In forex is much higher. In forex you can go to crazy number like 20, 50, 100, 200. And then you may be wondering why the hell the broker is lending you money. Now you have to understand this. First you have to pay the broker interest on the money that is lending to you. So this is a first gain for the broker. But the second one, and probably is the most important is that very often people will use leverage in the wrong way. And, and this means that they will lose the whole capital. Okay? Now especially when you are using derivative instrument like CFD where the broker is on the other side of your trade, they are very happy if you are losing. Why I say that leverage can kill your account? Well, because the risk of using leverage is confusing this number with this number. What do I mean by that? This is the real money that you have. So this is your money, what you have, this is what you have. What is available for trading, what is available for buying share. But it doesn't mean that this is your money. Okay? This is a very important thing. If you open an account and then suddenly you deposit 10k and then you, you have, because of the leverage, 20, 30, 40k. It doesn't mean that you can that now you are rich and then you have four times what you had before, or two or three. No, it just means that you can buy that amount of shares or whatever you are trading, but your money is this, you still have 10k. Okay? Now what is the problem? The problem is that sometimes people think that now they have more. Especially when you have a crazy leverage. Let's say you have 10 times leverage and then you are oh wow, now I have 100k. Great. I can buy 100k of stuff. Well, problem is, if you buy 100k of stuff, what happens? Well, as you still have 10k, only if there is a drop in price of 10% of your 100k then you lose 10k, right? And this means that you end up with zero because that's what you had at the beginning. You just get an illusion to have more money because of the leverage. But that's not your money. It's just money that the broker is giving you hoping that you will over trade so you will basically go to zero. I know I'm repeating this many times, but I really want to make clear the distinction between the money that you have, what you deposit and the money that you can use because of the leverage. Don't even make the mistake to think that this is your money, this is not yours. Okay? This 100k or 220 according to what is the leverage, is not your money. This is your money, this is yours. And why is this important in trading? Actually, I want to mention this because I think it's very important. You know very well that there are people that are doing trading and then there are people that are doing investing. And these two things are quite different. You need to use different strategy and different risk management. And one of the main reason why people make this mistake is because they confuse investing with trading. Because when you do trading, you need most of the time to have leverage. Otherwise you will not be able to trade. Let me give you an example. We can erase this. Okay, maybe. So let's say that you are trading and let's say that you want to buy Amazon. I think the price now is around 2,000 US dollar for share. Okay? Now if you want to buy this Amazon, let's say that your stop loss, if you don't know what is a stop loss, is basically saying that you are buying here. Okay, let's say the price today is, I don't know, blah blah, blah, is here, you want to buy here and you put your stop loss here. What does it mean if the price will later go down and hit this level, you will close your position, you will sell your share to cut losses and stop loss. This way is very important because you can basically define how much you risk for every share you buy. So if for example you buy at 2000 and you, your stop loss is at 1, 9, I don't know, 50, it means that you are risky. $50 for share, okay? And usually the thing is that you should risk for every trade 1 to 2% of your capital. Okay? So suppose that your capital is 10k again and your 1% is hundred dollars. Okay? Now if you want to risk hundred dollars with this kind of trade, every share you are risking 50, you need to buy two shares, right? So how much money do you need? Since you are buying at 2,000, you need $4,000. And it's fine. But suppose now that in instead of putting my stop loss there, for some reason, the stop loss is closer. Suppose that the stop loss is at 1990. Okay? So you're risking $10 for shares. Now if you do that, how many shares do you have to buy? Well, you have to buy 10 shares, right? Because every share you risk $10. But if you buy 10 shares at 2,000, then you need $20,000 of capital. But you only have 10,000. That's why you need margin, you need leverage. But again, leverage here in trading is just used to buy more shares. But remember, you are still risking 1% of your real capital. That's your risk. So in other words, you need leverage because shares may be too expensive or your stop loss for some reason is very close to the entry price. And so you need the leverage to be able to afford the position. But it doesn't mean that you are buying 20k as if you have 20k. Okay? You are still risking 1% of your real capital. Okay? So when you hit stop loss, you will lose $100. Now it may happen that you have gapped down and other situations, so you may not lose exactly hundred dollars. But the idea of trading is to manage the risk this way. So in this case the leverage is good. Okay? That's the good way to use the leverage. Because this way you will be able to afford to buy more and then to have a portfolio with more than 5, 6, 7 stock. If you have no leverage, you can only buy position where this kind of position sizing is giving you total amount that is below your capital. And usually when you buy four or five stocks, you have already used your whole capital. So leverage here is important. But what happens when you invest? Now in investing, usually first thing is you have no stop loss. What does it mean? It means that you buy something and you hold, so the whole capital is at risk. In other words, suppose that you buy in the example before your Amazon, okay? And then you buy a 2,000, $2,000 per share and you buy 10 shares. It means that you have $20,000 in Amazon and this is your real risk because you don't have any stop loss. Okay? Now what is the problem here. Suppose that the price of Amazon goes down, goes down, goes down. And suppose there is a new crisis or whatever happened. And remember, you still have your capital. You still have your capital at 10k. Okay, suppose for some reason that there is a drop in price of 50%. Okay, so now you have lost 10,000. Your Amazon is worth 10,000 and you have lost 10,000. What happens in this case? Well, in this case you get what is called a margin call. What is a margin call? Margin call is basically the following. The broker gave you some money. In this case you have 10,000. The broker is giving you other 10,000. And of course you have to pay interest. The moment the drop in price is causing your real capital to go near zero, the broker will say, you know what? Unless you top up with some more money, I will close your position because I don't want to lose money for you. You can lose your money is up to you. But then I don't want to lose the money that I gave you because that's not your money. Again, that's the mistake. That's the money of the broker. The broker is just giving you that money so you can buy more, but it's not your money and the broker doesn't want to lose his money. So what it's doing, when you are approaching zero, you will get this margin call. That is basically again the situation where you can decide if you put more money, fine. If not, I will sell your position and then I am fine, and you basically will have lost everything. So that's probably the main reason why people lose money with leverage. Because they don't understand the difference between trading with a stop loss, where you risk a fixed percentage 1, 2% of your capital, again your capital, and investing where you have no stop loss. And so if you use margin, it can be very risky. I'm not saying that in investing you cannot use leverage. You can, but you really need to be very, very careful. You really need to understand what you are doing because you want to make sure that you never get to this situation of margin call. Okay? This is something that you should avoid because margin call basically means that your account is dead. So if there is one thing that I really. Would you like to bring back home from this video? And again, you may think that I'm repeating this too much, but really, I've seen many situations where people are not clear about that and then they lose everything. So it's really, really, really important that you understand this when you are doing trading. Maybe we can write it so Leverage in trading, that means stop loss and you have your risk management. Then, okay? The only warning is that you have to risk a fixed percentage of your original capital, not the leverage capital. Okay? This is important. But in investing my suggestion is do not use leverage, okay? It means if you want, if you have $10,000 and you want to create a portfolio, just buy $10,000 of shares. Because you know that the worst thing can happen is you go to zero. And this will happen when all your shares value go to zero. That is basically impossible unless you really buy very, very risky cheap penny stock or something else that can go to zero. But usually it's very hard if you do your homework that you choose lousy companies. Because investing usually is doing some more fundamental analysis to find good companies that in the long term will go up or maybe etf. But if you use leverage, as with the example of Amazon, you may have your account, you may see your account go to zero even though the share price is not zero. And also the other thing is that as you have to pay interest is really expensive if you hold for the long term. Usually in investing you may hold for long term. So you may have to pay a lot of interest. So really remember how leverage can be used. Is a good thing or a bad thing? It depends. But what is really important is understanding this concept. So you will probably not commit the mistake that many people commit at the beginning. That when you see your capital suddenly 2, 3, 4, 10 times of what you have, then you get overexcited and then you start to buy more than what you should. And that's when you lose more than what you should. That usually means everything or even more. The problem is when people do short selling. And in that case it's even more risky because you know, when you do short selling and you buy too much, the problem is you may risk more than what you have. Short selling, that means I first get the shares from the broker and then I sell and then I will buy back later. If there is a huge increase in price for some news or some other event, you may lose more than the capital that you put. So this is another thing to remember because there were situations where this happened and it may be painful. So with that I would like to conclude the video again. Remember this, Watch the video again. If you are not sure, you can write me a comment because this is one of the most important thing to get it right. If this is not clear, my suggestion is don't even start. Really, you need to be hundred percent clear of how this works. Because otherwise the risk is really that you can lose everything. So thank you, as usual, for watching the video and see you next time.