Understanding Leverage – There Is No Substitute For Hard Work

The Leverage Dynamic

Aagh… leverage, the wonderful tool that works so well when you are in sync with the market, and so destructively, when you are not. This is the reality that will so often be disguised by greed and selfish ambition. Working with leverage needs to be done with extreme care and experience. It took me years to develop a strategy that I could trust and enjoy peace of mind. One of the most important tell signs that you are overleveraged is your inability to sleep. The problem with being overextended is that there is no way to repair your situation. Actually, there are two ways that you can adjust your risk profile, but they are often outside of your reach. Firstly, if the market turns in your favor, pressure and risk will decrease. However, if you are in the heart of a bear market, you are unlikely to experience this dynamic.

The second option is to provide additional collateral. However, for many, this is also not possible. It is the very reason why they are making use of leverage, in the first place. If you utilize leverage with the correct approach, risk management, and strategic counter-plays, you are likely to succeed. However, discovering “what this actually looks like” in practice is the most challenging aspect of utilizing leverage. The recent FTX drama is evidence of extremely poor risk management. It always comes down to the same problem: What are you going to do if things don’t go your way? Regular readers will be aware of my strategic approach of having a backup plan for my backup plan… with even additional backup!

I plan for failure, not success, for the simple reason that success doesn’t require assistance. Do something correctly and you will enjoy the rewards. On the other hand, unforeseen events creating havoc require strategic responses. How is it that Bankman-Fried exercised such poor risk management and monetary policy? We have addressed this many times on this blog. The key to preserving and growing large amounts of capital is to reduce risk and pursue modest gains. Once again greed and a lack of strong character are at the heart of this tragedy. A leader of strong character, with his emotions in check, would not have experienced yesterday’s events.

The Shortcut

For many, leverage is a shortcut to wealth. An avoidance of hard work and effort, and most importantly, time! Investors are generally impatient and want to see returns immediately. They are unwilling to put in the time and effort. This is a massive problem in the Crypto world. Every single swan event during this bear market can be linked to some kind of overextension or greedy outworking. Moving beyond healthy levels, and beyond sound money principles, ultimately gives birth to death. This is what I am talking about in relation to character. You can excel, and even get “lucky”, but do you have the character to maintain it? If not, eventually it will trip you up, and often when you least expect it.

The best approach is to never rely entirely upon a leveraged approach and to continue working as if it didn’t even exist. There are three very important points to my personal strategy when it comes to leverage.

  • Ensure that you have an enormous cash buffer
  • Set strategic entry points
  • Make use of modest leverage

When it comes to the final point, it is important to understand this in terms of collateral, as well. Don’t make use of an extremely volatile or “fragile” asset as collateral. This is also the case when it comes to an asset that is vulnerable to manipulation. Rather avoid utilizing such assets. There are so many aspects to investing and trading that unfortunately can only be understood and realized through experience. Many wealthy and “successful” Cryptoneurs, are at this very moment, receiving and experiencing an introduction to the “school of hard knocks”. How will they surface on the other side? I have no idea.

Final Thoughts

I have published a number of articles in regard to trading, investing, and growing accounts. I have made a special point of emphasizing the importance of learning the ropes with small amounts of capital. There is no way that you can avoid the lessons that the market has destined for every market participant to “learn”. It’s best you do “your time” now, and with insignificant amounts of capital. Besides, if you are an effective trader, you won’t necessarily require large amounts of capital to build something of value over time. I think this bear market has provided enough warnings to investors.

Evaluate and adjust your strategies, if need be, because they will be tested. Some might avoid destruction today, but an unhealthy approach will eventually succumb to the power of the market.

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