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Leverage: the 9th wonder of the world?

Fusion Markets

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Albert Einstein was once asked what the most powerful force in the universe was. After a thoughtful pause and not without a sense of humour, he replied that it was compound interest, which he would later describe as being the world's eighth wonder.


If we were looking for a candidate to fill the number nine spot on that list, we could easily pick another innovation from the world of finance; leverage.


If we look at a dictionary definition for the term, we find the following.


"The use of credit to enhance one's speculative capacity"


The concept of financial leverage is probably most familiar to us in a mortgage loan, a loan secured against a property.


To secure a mortgage, it’s normal for the buyer or buyers of the property to put down a deposit that acts as their “skin in the game”.


A bank or other lender finances the purchase price balance through a loan that runs over a fixed term, usually measured in 25-30 years.


This is made at a known or referenced rate of interest, which may be fixed or variable over the loan term. For example, the rate may be set at central bank base rates +X%.


The buyer of the property finances the loan through the payment of interest, which compounds over time to make the lender a healthy return on their loan, assuming all goes well.


The ever-present longevity of a mortgage and the nature of its commitment can be summed up through a literal translation of the word mortgage from the French, where it means “death pledge”.


Of course, that rather sombre definition only looks at the liability side of the transaction. It doesn’t take into account the opposite side of the coin, and that is the asset that the mortgage is taken out over.


All things being equal, the asset will have appreciated over the lifetime of the loan. And in modern times, it will have often done so to such an extent that its value now exceeds the loan's original value.


Under those circumstances, the death grip is loosened and may even be released completely if the property’s owners choose to sell it and repay the outstanding mortgage balance.


That’s all very interesting, but what has any of this got to do with trading and investing?


Well, just over 20 years ago, traders in London had the great idea to introduce leverage into OTC financial instruments such as CFDs and rolling spot FX.


This effectively democratised the availability of leverage in trading by providing it to the man in the street who could now gear up their trading account and speculate on the markets in a way that wasn’t possible before this point.


The availability of leverage in margin FX and CFD trading was a marketing team's dream. A whole new industry sprung up to offer these products (which had previously been the preserve of hedge funds) to retail traders.  


Eventually, competition for that business was such that brokers began to raise the levels of leverage that they offered to their customer base.


Put simply, that meant that traders could control an ever-larger parcel of stock, an equity index or FX pairs with a smaller and smaller deposit, which brings us to today.


It all sounds great. Because, of course, if your position was leveraged 500 times, then so was your P&L. A dollar profit became 500 dollars.


Well, not so fast because leverage is a two-way street that magnifies profits and losses.


And whilst leveraged positions in profits create equity in your account, leveraged positions that are in loss eat away at your account balance and ultimately undermine it completely.


Events in the spring of 2021 highlighted exactly why traders need to respect and control their use of leverage, and the consequences of not doing so could not be clearer.


Bill Hwang of Archegos Capital Management, a hedge fund turned family office with $20 billion in assets, effectively evaporated overnight thanks to a combination of risk concentration and excessive leverage.  


Put simply, the fund had too much money chasing too few positions.


You might have thought that having $20 billion to invest would mean that you wouldn’t need access to leverage, but Archegos Capitals strategy was to leverage that vast sum by as much as 7x times through a network of banks and brokers. The trick was that none of these banks knew just how much leverage the other parties had offered Archegos.


But no one, not even a hedge fund of that scale, is bigger than the markets, and when some of these positions fell in price and value, the fund’s brokers asked for additional margin to shore up its trading accounts.



By this stage, the banks were concerned about their own liabilities and whilst they were talking to each other about they should proceed, one or two of the banks started to try and close out the positions they held for the hedge fund.


Once word got out that this was happening, it became a free-for-all, and the stocks that Archegos held plummeted. And that, of course, created even larger margin calls that the fund had no hope of meeting.


Below is Archegos' biggest positions in their fund and how quickly things folded within a couple of days after the music stopped. ViacomCBS, a respected US media company, fell by over 50% in 2 trading sessions.




These events reinforced another lesson for traders - the one that says the end of the party is never pretty if everyone heads for the exit simultaneously.


It also reminded us of how an imbalance between supply and demand can influence prices (Gamestop or AMC, anyone?)


You probably haven’t got $20 billion, but you do have your nest egg and trading capital that you worked hard to build up. Please don’t blow it by leveraging and concentrating your risk in one or two big positions.


A disciplined approach to money management and risk is the key to successful trading and investing. When you don’t use that disciplined approach, it often goes horribly wrong, as the former Hedge Fund Archegos Capital found out.


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Why You've Got a Bigger Advantage than Professionals
Fusion Markets

You’ll often hear in the media or from professional market participants that retail clients “shouldn’t try to compete with the professionals”.


Ignoring the condescension here for a moment (“the adults will take it from here”) it is my firm belief after ten years of trading that this isn’t always true.


Sure, any beginner will find it challenging at the beginning to trade successfully, but you can’t expect to play like Roger Federer after one match of tennis, can you?


Charlie Ellis, the man who oversaw the $24 billion Yale endowment fund in the US once, said “watch a pro football game and it's obvious the guys on the field are faster, stronger and more willing to bear and inflict more pain than you are. Surely you would say ‘I don’t want to play against those guys.”


But Charlie is wrong in a few ways.


Yes, professional traders and institutions have many advantages at their fingertips. They get news faster than you do. Their trades go more quickly than yours. They pay far less than you do. You get the picture.


But it’s not all doom and gloom. Here are a few reasons why:


Time


No, not in the sense that you have more actual time to trade than them.


You probably don’t.


You’ve probably got a full-time job.


You might have kids or ailing parents to look after.


Trading is like a side hustle for you.


BUT your time horizon is different from theirs.


You can hold a trade for days or weeks without a Manager yelling at you “Why the hell are you selling euros, you dummy… the market is going up”. You might enter a trade on gold and plan to hold it for months.


A professional fund manager or trader might not have that luxury due to quarterly reviews, investor pressure or whatever else.


Professional Risk


Professional or Career risk is one I picked up from famed value investor, Howard Marks. In his book “The Most Important Thing” (one of my favourite investing/trading books of all time – buy it!) he talks about how in the GFC there was so much pressure on investors to not look silly by calling the bottom of the market or “catching a falling knife”. No one wanted to be the guy in the office who was buying Citibank at $1 per share!


Similar to my time point above, you don’t have that problem.


You don’t have your colleagues questioning you why you’ve bought or sold some instrument. Or a boss that is screaming at you and putting you into an emotionally defensive position trying to justify your actions.


Will you lose your job for selling USDJPY? No.


Does a professional trader get fired for always missing targets or taking on too much risk? Yes.


You need to work out what you’re happy with in your trading goals and go for them.


It’s entirely up to you what you define as success. The Pros don’t have that luxury.


Benchmarks


Which brings me to my next point.


Most professional traders and investors have a benchmark. If you’re a fund manager you’ll send out your monthly report to your investors saying “here is how much we made/lost.. and here is what the benchmark did”.


If you miss that benchmark, get ready for investor withdrawals. As a professional, you’re judged on your performance. Simple as that. The more investors leave. The more you have to sell. The more you sell, the worse your performance!


What’s your benchmark? You get to set your own. Happy with 1% a month? Awesome.


What about $100 a month so you can buy your wife dinner? Happy days.


Or $5,000 a month so you can pay off your mortgage? Even better.


It comes back to autonomy and your desires. No one else decides that but you.


Fees and Expenses


Believe it or not, you do have a HUGE advantage here, especially if you’re trading with a low-cost broker (hello, Fusion!)


If you’re a professional investor/manager, you’ll often have a significant research team, a very fancy office with lovely views, staff bonuses, visits to various investment conferences etc.


Not to mention all that travel to see your clients and investors!


Putting that aside for a moment, if you choose a good broker, you’ll pay zero spread and a small commission that is not far off what the pros trade. They’ve got $100,000,000 though, you’ve got one thousand!


So, ignore the haters telling you to stay out of the market because its only for the big boys.


However, let me be clear.


I’m not saying trading is easy and (unlike some) and that you can soon retire on the beach. It’s not. Trading FX, in particular, is a highly challenging exercise.


But don’t just assume because there are so many professionals in this that you can’t succeed or you’ll never be good enough. You have to play your own game, and for me, that’s the best part. I set my own rules as to what I consider success. That’s something the pros will never get.  


If you’d like to start trading and use your advantages to outperform the pros, Sign Up to Fusion Markets and get your feet wet with our demo account. When you're ready start a live account to start making real-time trades.

Trading Strategies
Financial Markets
Retail vs Professional
Market Trends
24.02.2022
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Ethereum Trading: All You Need to Know
Fusion Markets

What is Ethereum?  


You may have heard of Ethereum being compared to Bitcoin, but Ethereum isn’t actually the digital currency itself. Instead, Ethereum is the technology that can run various financial services like payment systems, identity software, security programs, and of course, cryptocurrency trading.  

But how does this technology work?  

Like Bitcoin, Ethereum also uses blockchain technology, but there are quite a few differences on the deeper, more technical side. Blockchain technology is the foundation that supports all of Ethereum’s services.  

The biggest feature of Ethereum is that it is a programmable blockchain. This means that you’re free to use the technology according to your own needs. Whether you need it for payments, software, or even Bitcoin, you’re free to do that!  


Some of the world’s biggest companies are using blockchain in various ways, which shows how flexible the technology is. BMW, the renowned automaker, is using the Ethereum blockchain to track materials across its supply chain.  

De Beers, the biggest diamond mining company globally, is using the Ethereum blockchain to track diamonds from mining to selling. HSBC is also using the blockchain to conduct foreign exchange trades on its FX Everywhere platform.  

The blockchain can be used on just about any technology that requires information to be logged and verified.   

But if you’re here reading this article, you’re probably more interested in investing in cryptocurrency or buying cryptocurrencies. That would be ETH or Ether.  

  

What is the difference between Ether and Ethereum?  


If Ethereum is the technology, then Ether is the cryptocurrency that runs on that technology. However, for most people, “Ethereum” and “Ether” are used interchangeably to refer to the digital currency instead of the technology.  

The shorthand for Ether is ETH, and just like Bitcoin, ETH is a form of decentralised finance or “defi.”  

This means that the digital currency is not centrally regulated by one authority. Instead, all the computers on the blockchain do the work of validating each and every transaction on the network.  

Ether is up there with Bitcoin as one of the most highly traded cryptocurrencies globally, along with Ripple XRP and Litecoin and others available on Fusion Markets’ platforms.   

  

The benefits of trading Ethereum  


As with any digital currency, the biggest benefit of trading Ethereum is the lack of centralised regulation because of blockchain technology. This means that making fraudulent transactions on the network is extremely difficult and almost impossible.  

However, one thing that makes Ether different from Bitcoin is that the supply of Eth is limitless.  

Let’s break it down a little bit.  

The way Bitcoin works is people are constantly “mining” for Bitcoin. However, there is a predefined limit for the amount of Bitcoin that can ever be in circulation. Once all the available Bitcoin has been mined, that’s all the Bitcoin that will ever circulate.  

The Bitcoin mining rate slows down over time, so the prediction is that the last Bitcoin will be mined at around 2140. That’s over a hundred years from now, but it’s still a definite time that will arrive.  

For most people, the problem with the limited supply of Bitcoin is that it can create issues like high inflation levels in the future.  

The supply of Ether does not have the same limitations that Bitcoin has. Thus, it can be more stable in its fluctuations, and this effectively works as a hedge against extreme inflation.  

Ether is also less volatile, at least when compared to Bitcoin. So if you’re looking to invest or trade in cryptocurrencies, but you want to minimise the volatility, Ether may be right up your alley.  

  

Risk Management when it comes to Ethereum  


Despite the lower volatility levels of Ethereum, it is still a cryptocurrency. This means that unlike more traditional investments like stocks and forex, its price is still quite volatile in comparison.  

So, when trading or investing in Ethereum, it’s essential to employ risk management practices.  

First, only use as much money as you’re willing to lose. This is a basic precept for investing or trading in general, and it applies to Ethereum as well. The price of ETH in 2021 may be high, and it may look like it will continue to rise, but no one can really predict the next price movement.  

Second, diversify. Don’t put all your eggs in one basket. If you want to trade cryptocurrency, make sure to allocate your funds across multiple digital currencies. That way, if the price of one plummets, you still have your holdings in other cryptocurrencies to rely on.  

Third, do your own research. Don’t rely on social media gurus or finance forum posts that tell you when to buy or sell. Cryptocurrency is a fairly new concept, and it’s pretty much still in its infancy stages.   

If you’re investing in ETH, make sure that you understand it, how it works, and what the technology behind it is.  

A good investment is one where you believe in the product you’re investing in.   

While it’s true that no one can really predict how the price of the cryptocurrency will move, it’s much safer to put your money in investments that you’ve done research in instead of just blindly following what you see on social media.  

Finally, make sure to monitor your own physical and mental health while trading cryptocurrency. The markets run 24/7, and you don’t want to be looking at charts all day while ignoring your own well-being.   

Taking care of your mind and body allows you to make better, more rational trading decisions, dramatically reducing the risk.  

Risk management is a fundamental skill that any reasonable investor or trader should have. There are plenty of risks when it comes to ETH and cryptocurrency in general. Risk is unavoidable, so the best thing we can do is to manage and minimize it.  

  

The Future of Ethereum  


Despite cryptocurrency being a new concept and Ethereum being fairly more recent than Bitcoin, its rise in the charts shows that it’s here to stay.  

The main selling point of Ethereum is how its blockchain technology compares to Bitcoin, and with the number of people investing in or trading ETH, it’s clear that there is widespread acceptance and trust for ETH.  

Will ETH keep its place as one of the top cryptocurrencies in the future? The truth is, nobody knows. Governments are still only beginning to recognise and regulate cryptocurrencies, so the future of ETH is, as a whole, uncertain.  

But for some people, that uncertainty is what makes ETH such a good investment. Hopefully, this article has helped get you started on the basics of trading ETH. 

 


Ethereum Trading Cryptocurrency
Education
22.10.2021
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