Over leveraging trades is probably the top day trading account killer. Therefore, I list it as a top misstep in my article 25 Fatal Day Trading Mistakes. New traders often blow up accounts betting with huge percentages of their accounts on single trades in an attempt to maximize gains. This causes several issues that can destroy profits. Avoiding this trap is one of the most important things I discovered while evolving my trading strategy. Once I stopped, it had a major impact on my trading success. Sadly, most people have to learn this particular lesson the hard way. This is because when you first start trading, you just don't know enough to understand why it is so dangerous. My trading improved a great deal when I began utilizing smaller size and shooting for consistent gains. Anybody can hit a big trade now and then. If you leverage enough money and you are right, of course the gain will be large. However, most people don't advertise the big losses that come along with this type of behavior. All that matters is your gains over a greater time frame such as six months to a year. Anybody can get lucky for a while, but what is much harder is being profitable on a regular basis. Below are ten reasons over leveraging can be an account killer...
1. Accelerates losses. When you start out trading with a small account its easy to get sucked into going in heavy to try and maximize the gain. If you are right, you are going to win big. But, if you are wrong you will also lose big. It can start a downward spiral that can lead to major problems down the road. Another factor that traders often forget about is that the gain required to make back a loss is much larger because you now have less capital. Never forget that Rule #1 is Don't Lose Money.
2. You miss other opportunities. One of the worst things about over leveraging is that you can get stuck being what's called an "ostrich." You stick your head in the sand and hope a trade goes your way. I've been here and it certainly is not fun when a trade is going badly against you. If all of your buying power is used up, you cannot trade other great opportunities that may be even better than the one you are stuck with.
3. Margin calls and restrictions. Over leveraging trades will lead you to margin calls and day trade calls because it often times comes along with exceeding your buying power. This can lead to restrictions and even more hassle. It is especially the case with shorting where you can technically lose more than 100% if a stock moves against you.
4. High Stress due to increased fear. When you are in far too heavy it can be a highly stressful experience. This is because deep down you know if the trade starts to go against you, you are in serious trouble. High stress leads to greater fear and therefore will cloud your decision making. Exiting at the worst time is common when in this situation.
5. Wastes more of your time. If you are taking big trades you will find yourself staying up later to do research and you will end up having to get up at the crack of dawn to eye the stock. You will find yourself so enamored with the trade that you will not even be able to leave the computer. I know that sounds crazy, but its very true. Anxiety levels will be high and a slight change in movement can make you very uncomfortable.
6. More easily influenced by talking heads. You are going to find yourself much more influenced by what other people are saying about a stock. Fools on social media or television will say things that you might otherwise ignore and they can get in your mind a lot easier when anxiety is heightened.
7. Market makers will drive you crazy. If you find yourself trying to exit a large position market maker algorithms may take advantage by raising or lowering bids and asks. Also high frequency traders are always attempting to front run you.
8. You will lose sleep. If a trade goes against you, you might try to swing it in an attempt to get back your unrealized loss. In a case like this you can forget about sleeping. And obviously this can have a bad impact on other aspects of your life.
9. It eats up your buying power. When you are over leveraged, your buying power will be much smaller or non-existent. Therefore, you will not be able to enter other trades that you may find interesting. The following day it will start at zero if you are holding 100% of your cash in a stock overnight.
10. You can end up owing your broker. If you go in with something like 200% leverage and a stock goes badly the other way, you can lose your entire account, but you can also end up owing your broker even more money. Most brokers will allow you to leverage four times your money if you are designated PDT (Pattern Day Trader). However, this is like pouring gas on a fire. A good example is when the KBIO fraud ran 1000% on the supposed stake by the snake Martin Shkreli. This destroyed accounts of those who were holding short big overnight. It was so bad, a trader named Joe Campbell actually started a Go Fund Me page just to try and pay back the $100,000 he owed his broker E-Trade. It's best to avoid shady bankruptcy related stocks.
The bottom line is over leveraging is something to avoid. Certain setups may be better than others and you do want to know when to capitalize by going heavier and when to go lighter when the setup is less exciting. One of the most important things a trader can realize is that choosing to not over leverage will seriously improve your trading success. If you are skeptical and decide to ignore this advice, be ready to pay a high price in tuition cost. Newer and more experienced traders would be very wise to seriously take this article to heart. Take the stress off of yourself by entering trades with 10-15% of your cash and avoid altogether borrowing money from brokers. Please do not be the next trader to have to start a Go Fund Me page!