Avoid Too Much Leverage

Avoid Too Much Leverage
Photo by Joshua Earle / Unsplash

At times of high volatility, the best is to reduce leverage, in particular if using spread betting or CFDs to trade the markets.

At times like this, too much leverage is a deal-breaker

When the Covid-19 hit Europe, equity markets were battered down and quickly entered bear territory (20% below the peak). February and March were like hell for long-term investors, who saw their holdings being depressed over just a few sessions. As I reported in a previous article Is It Time To Bet Against Covid-19, it took the Dow Jones just 19 sessions to enter a bear market, which compares with 180 session during the 2007-2009 financial crisis. However, after closing at 18,591.93, the Dow managed to recover to 23,775.27, a figure recorded last Friday, 24 April, and representing a recovery of 28%. From its peak on 12 February, the Dow is still down by 19.5%, thus near bear territory.

Dow Jones

Dow Jones in 2020

My point today is not about how high or low the Dow is going but about the impact of volatility. After 23 March, when the Dow hit a 2020 low, it reverted direction. But the path has been very uncertain, full of ups and downs. Investors are very sensitive to every piece of information (or the lack of it) trying to discern what’s likely to happen in the near future. Last week, for example, two announcements regarding the failure of hydroxychloroquine (first) and Remdesivir (after) as the anti-viral solution for Covid-19, quickly led to a reversion of market direction.

The market is made of ups and downs, which are the consequence of the news flow. But at these sensitive times, the movement is more exacerbated, as investors are looking for clues about a very uncertain future. We do know that viruses come and go away. However, we are not sure about the impact this particular virus will have in the global economy. We had never been locked at home like we are now and a large part of the developed world is still under confinement measures, which means a drag on consumer confidence and activity levels. While Trump will certainly try everything to boost the U.S. economy (to improve his reelection chances), there are uncertain choices coming from Europe. And we don’t really know if China will regain its share on global production, as Europe rethinks on how dependent it want to be from China in the future.

In terms of long-term investment, this is a time of opportunity to add a few battered down stocks from industries like oil/energy. In terms of short-term trading, which usually trades on margin, this is a time to reduce leverage. We will assist to high volatility because the virus isn’t gone yet and because we are just at the start of the recession. Most spread betters and CFD traders do loose money, not because they’re wrong about market direction but because their highly leveraged positions are closed on margin calls. Reduce exposure to a level that allows you to sleep at night and just be patient.The key to profit in the short-term is to give some margin to your positions.

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