Foundations · Lesson 7 · Beginner
Leverage: what it really does
You understand that leverage amplifies gains and losses non-linearly and only finances the position size.
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What leverage does
At 10x, 1,000 USDT controls a position of 10,000 USDT. A move of 5 percent in the market is then not 5 percent on your capital, but 50 percent.
The deadly non-linearity
Anyone who thinks an X percent move is an X percent gain or loss systematically underestimates the risk. Leverage only finances the position size, it does not determine it.
Same move, three leverage levels. Slide the move and see what your account does at 2x, 10x and 25x.
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Test yourself
A 5 percent move against a 10x position is what loss on your capital?
- 5 percent
- 10 percent
- 50 percent
Sign up free for the answers with an explanation for each option.
The key points at a glance
- At 10x, a 5 percent move is a 50 percent result on your capital.
- Leverage only finances the position size from the position-sizing formula, it does not determine it.
Deep dive
Why ROE is not the same as price movement
ROE, return on equity, describes your stake, not the market. If your 10x long shows plus 630 percent, the coin has only risen about 63 percent. The number works in both directions.
- Goodman's account in 2021: DENT plus 1231 percent ROE, ADA plus 630 percent
- 10x leverage turns a 10 percent move against you into a 100 percent loss
- A high ROE is just unrealized paper profit, not a buffer
- Goodman only saved the gain by exiting in time before 2022
Only the stop distance sets your position size
Elder, Taleb and Goodman independently arrive at the same rule: leverage does not change your position size. First you set your risk, then you place your stop based on the chart, and only from that does the number of units follow. Leverage then merely finances those units.
- 10x leverage with 2 percent risk per trade is survivable
- 1x leverage with 20 percent risk can blow up your account
- Life and death are decided by the stop distance, not the leverage figure
Why a leveraged trader is selling an option
Taleb gives the why: if you are leveraged, you have written a short option on volatility. You collect small, calm gains and carry a rare risk that wipes you out in one hit. Accounts die at the extreme, not on the average move.
A hard stop flips this around: your maximum loss is the one R, your gain stays open. With this convex payoff you can be right less than half the time and still make money.
Sources: Goodman, Taleb, Elder
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