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  Leveraged Trading

  A professional approach to trading FX, stocks on margin, CFDs, spread bets and futures for all traders Robert Carver

  Contents

  Abou t the Author

  Preface

  Who should read this book?

  How does this book differ from my first book, Systematic Trading

  ?

  What’s coming

  Introduction

  The mistakes that losing traders make Why leverage is dangerous

  Why you should use a system when you start trading How is this book different from other trading books?

  Part One: Fundamentals

  Chapter One : Types of Leveraged Tra ding Product Introduction to leveraged trading

  Three key characteristics of leveraged products What products are there for leveraged trading, and how do they work?

  Products and underlying instrument are different Chapter Two : Getting Ready to S tart Trading 1. Choosing your trading software, hardware and data feed 2. Choosing which product to trade

  3. Choosing your broker

  How much money do you need?

  Chapter Three : Introduction to Tra ding Systems Why you should use a trading system

  Common arguments against using trading systems What makes a good trading system?

  Why you should avoid third party trading systems Part Two: Start ing to Trade

  Chapter Fo ur : Concepts

  Some definitions

  Risk and return concepts

  Minimum trades and minimum capital

  Costs

  Chapter Five : Introducing the St arter System An overview of the system

  Which instrument and product to trade?

  When should we open positions?

  How large should positions be?

  When should positions be closed?

  Chapter Six : Trading the St arter System Before you start trading

  Tasks on day one

  Tasks on subsequent days

  Trading diary

  Summary

  Part Three: Diversifying

  Chapter Seven : Adding New Markets

  Advantages and disadvantages of diversification The theory of diversification

  Trading the Starter System adapted for multiple instruments Chapter Eight : Adding New T rading Rules The case for diversification of trading rules My suite of trading rules

  How do we use multiple trading rules?

  Using multiple trading rules in practice Part Four: Adva nced Trading

  Chapter Nine : From Discrete to Contin uous Trading Why it can be safe to trade without a stop loss Continuous trading

  Practical trading without a stop loss

  Chapter Ten : Positio n Adjustment

  Adjusting position size for confidence: non-binary trading Adjusting position size for risk

  Adjusting position size without incurring heavy trading costs Practical non-binary trading

  Chapter Eleven : What Next?

  1. Improvements to the Starter System

  2. Back-testing and designing your own system 3. Semi-Automatic Trading

  Epilogue

  Glossary

  Appendices

  Appendix A: Useful Information

  Further reading

  Useful websites

  Appen dix B: Costs

  Transaction costs

  Holding costs

  Total costs

  Minimum capital and costs

  Smarter execution to avoid the spread

  Appendix C: Calculations

  Back-adjusting prices

  Instrument risk calculation

  Moving average calculations

  Breakout calculations

  Performance ratio

  Ackn owledgements

  Publis hing details

  Reviews of Systematic Trading by Robert Carver

  “A remarkable look inside systematic trading never seen before, spanning the range from small to institutional traders. Reading this will benefit all traders.”

  Perry Kaufman, author of Trading Systems and Methods

  “Rob goes into a level of depth which most trading book authors either deliberately avoid or simply lack knowledge of. Rob’s background in the industry is beyond reproach and the informational contents of his book shows his experience and depth of knowledge. If you want to enter the professional systematic trading field, Rob’s book is a must.”

  Andreas Clenow, CIO Acies Asset Management and author of Following The Trend

  “Being a hedge fund manager myself and having personally read almost all major investment and trading books, this is by far one of the best books I have read in over 15 years on a tough subject for most.”

  Josh Hawes, Hedge fund manager

  “Robert has had very valuable experience working for many years in a large quant hedge fund, which makes the book doubly worth reading.... Well worth a read for anyone who trades, in particular for systematic traders (whether you’re a novice or more experienced)!”

  Saeed Amen, FX trader and author of Trading Thalesians Reviews of Smart Portfolios by Robert Carver

  “I’ve been a fan of Robert Carver’s work for quite a while now, and this book definitely adds to the knowledge and experiences he willingly shares with others. Carver skillfully mixes theory and practicality, making this a great reference guide for intermediate and very experienced traders alike. Highly recommended!”

  Kevin Davey, Champion full-time trader, author of Building Winning Algorithmic Trading Systems

  “In Finance (like many other subjects) there is a large amount of research that is smart but impractical and an equally large amount of popular literature that is practical but dumb. This book is in that rare category of smart and practical – it is also an entertaining read in its own right.”

  Francis Breedon, Professor of Finance, Queen Mary, University of London and former global head of currency research at Lehman Brothers

  “The book is a solid piece of work so check it out... It’s about the process and there are some really practical ways,

  mathematical ways, to put a good process in motion for your life.”

  Michael Covel, author of Trend Following

  “When you combine ignorance and leverage, you get some pretty interesting results.”

  Warren Buffett, legendary investor

  “… the best minds were destroyed by the oldest and most famously addictive drug in finance, leverage.”

  Carol Loomis, Fortune magazine 1998

  “Spread bets and CFDs are complex instruments and come with a high risk of losing money
rapidly due to leverage. 81% of retail investor accounts lose money when trading spread bets and CFDs with this provider. You should consider whether you understand how these products work and whether you can afford to take the high risk of losing your money.”

  Risk warning from a brokerage web page About the Author

  Robert Carver is an independent trader, investor and writer. He spent over a decade working in the City of London before retiring from the industry in 2013. Robert initially traded exotic derivative products for Barclays Investment Bank and then worked as a portfolio manager for AHL – one of the world’s largest hedge funds – before, during and after the global financial meltdown of 2008. He was responsible for the creation of AHL’s fundamental global macro strategy, and subsequently managed the fund’s multi-billion dollar fixed incom e portfolio.

  Robert has Bachelors and Masters degrees in Economics, and is currently a visiting lecturer at Queen Mary, University of London. His first book Systematic Trading: A unique new method for designing trading and investing systems was published by Harriman House in 2015, and his second Smart Portfolios: A practical guide to building and maintaining intelligent investment portfolios came out in 2017. Robert trades his own portfolio using the methods you can find i n his books.

  Preface

  Leverage (verb): use borrowed capital for an investment, expecting the profits made to be greater than the interest payable

  Oxford Dictionary of English

  Not so many years ago the use of leverage for trading was the exclusive domain of highly-trained investment professionals.

  Sharply dressed denizens of Wall Street or the City of London would happily borrow, and then gamble, hundreds of millions of dollars or pounds. But such risky behavior was not for the average Jo e (or Jane).

  Things have changed. With the right broker, and just a few hundred dollars or pounds, anyone can become a leveraged trader.

  In the US it is easy to buy stocks, or bet on them falling, with a margin account . UK traders can make spread bets or take out contracts for difference (CFDs) on their favorite shares, as easily as betting at the local racecourse. In both countries, and in many others, you can trade foreign exchange (FX) a nd futures.

  ¹

  Leverage has levelled the playing field for smaller investors, but it has also made trading riskier. Leverage is inherently dangerous. With too much leverage a modest trading loss can be magnified into a wealth-destroying explosion. Leverage also increases the costs of trading: doubling your leverage will double your trading costs. Traders who manage to avoid a quick death from blowing up will instead die slowly, with high costs gradually emptying the ir accounts.

  Because leverage is so dangerous, it is absolutely vital to use a safe level of leverage when trading. Deciding on how much leverage to use is the single most important decision that any trader will h ave to make.

  To protect yourself from the dangers of leverage it is my belief that you should use a system when you start trading. This comes from my own experience: I have traded leveraged financial products for an investment bank without a system, and for a multi-billion-dollar hedge fund ² that traded exclusively with systems. Now I trade my own money using purely systema tic methods.

  Trading systems have a poor reputation, but a simple system is much less likely to lose money than an inexperienced trader. If you use a system when you start trading, it will significantly improve your odds of becoming a profitable trader. A good system will calculate the right amount of leverage, protecting you from the dangers of serious losses and high costs.

  But finding a well-designed trading system is a daunting task.

  There are thousands of books and websites offering potential systems, many of which are badly designed and even potentially dangerous. Many system designers give scant attention to the importance of managing risk by controlli ng leverage.

  Instead they rely on incorrectly calculated stop losses ³ to limit losses (and indeed, as I explain later in the book, a stop loss is unnecessary in a properly-designed trading system). They are obsessed with finding the elusive perfectly accurate trading rule, when it is far more important to control risk and trading

  costs. They try and predict the price changes in a single market, but a good system designer knows that diversifying across many different markets is likely to be far mor e rewarding.

  In this book, I introduce a properly-designed, but also simple, trading system. I then explain how to improve its expected performance: by trading additional markets, and also through adding new features. Not everyone will want to continue trading with a system. As you gain skill and knowledge you may wish to start using your own intuition to make decisions about buying and selling. I will explain how to combine human judgement with a trading system, so that you remain protected from the dangers of excessive leverage. This method, which I call Semi-Automatic Trading , is described in the fi nal chapter.

  Who should read this book?

  This book is for traders who want to learn how to trade safely 20

  using leverage. It covers: 74

  20

  foreign exchange trading (F X 75 or Forex) futur es contracts

  contracts for difference (C FDs) trading sp read betting

  trading stocks with a ma rgin account

  No prior experience or knowledge is required, so this book is suitable for newcomers to trading. But even experienced traders should find the book useful, since I will be challenging many of the preconceptions that most people have ab out trading.

  You do not need much money to start trading leveraged financial products – just a few hundred dollars or pounds. However, you should only trade with cash you can afford to sacrifice, as with any kind of leveraged trading there is always a possibility that you could lose everything.

  The examples in this book are aimed primarily at readers from the US and UK. However, traders from other countries can also use the system I explain. Be aware that local regulations may ban or limit the use of certain leveraged products. Tax laws will also be different from country to country.

  H ow does this book differ from my first book, Systematic Trading

  ?

  If you read the ‘ About the author ’ section, you will see that I wrote another trading book a few years ago: Systematic Trading (

  ST ). Perhaps you are browsing online or in your local bookshop and trying to decide which of these two books you should buy.

  Maybe you already own ST , and are considering adding this book, Leveraged Trading ( LT ), to your collection.

  To help you decide, the main differences between the tw o books are:

  As the title suggests, ST is mostly aimed at traders who are enthusiastic about systems trading. LT helps new traders learn how to trade by using a system, but then explains how to combine the system with their own human intuition; the method I’ve named 20

  ‘Semi-Automati c Trading’. 76

  The trading systems in ST require large amounts of capital (at least £100,000; around $130,000). The Starter System in LT needs just £1,10 0 or $1,500.

  ST is written for relatively advanced traders with some prior knowledge of certain financial concepts. LT is suitable for novices.

  ST is a generic book which doesn’t go into much detail about individual markets. LT explains how to trade specific leverag ed products.

  ST explains the various components of a complex trading system one by one; it isn’t until the book is finished that you can see the entire picture. In LT, I introduce a simple system in its entirety which you can start using right away. I then go on to explain how, and why, you could make it more complicated.

  ST explains how to design trading systems from scratch, which requires using software to simulate historical system performance (a process called back-testing ). In LT, I present a system I have already back-tested. I then explain how you can modify the system for different types of trading, and to cover different markets, without needing any furt her testing.

  Becaus
e I have designed the trading systems in this book with the same principles in mind there are some ideas that readers of ST

  will find familiar, although there is no duplicated content in this book. I would recommend that you read Leveraged Trad ing (

  LT) if:

  You tried to read ST and di dn’t get it.

  You read and understood ST , but are struggling to build a simple system f rom scratch.

  You have not read ST and are an inexperienced trader who is unfamiliar with financial theory and back-testi ng software.

  You are specifically interested in trading leveraged products: FX, CFD, margin accounts, spread bets and futures.

  You do not have enough cash to trade the sy stems in ST .

  You are interested in combining your own trading intuition with a trading system: Semi-Automa tic Trading.

  Of course, if you find this book useful, are interested in purely systematic trading, and want to develop your own trading system further, then I’d definitely recommend making Systematic Trading your ne xt purchase.

  What’s coming

  This is a four-part book. Part one introduces each of the leveraged products we are going to use and explains how to make decisions about your tr ading setup.

  Then in part two I introduce the Starter System. The Starter System is a very simple trading system which trades a single instrument, using just one kind of trading rule to decide when to open ne w positions.

  Part three then explains how to extend the Starter System by diversifying into multiple instruments, and by adding new tr ading rules.

  In part four I introduce some more advanced improvements that you can make to the Starter System. The final chapter of part four explains how you can continue your trading journey, either by progressing into designing your own trading systems, or becoming a discretionary trader who makes subjective forecasts about market movements whilst still using a system to manage risk: Semi-Automa tic Trading.

  At the end of the book there is a glossary and three appendices

  . Appendix A lists some useful books and websites; appendix B

  discusses the calculation of trading costs , and some techniques for reducing them. Finally, appendix C explains how to perform various other calculations required to run a tra ding system.