Margin Trading Explained: Should You Trade Chinese Assets Using Leverage?

08
Jun

A lot of individuals claim they’re interested in “grabbing a piece of the China pie” without realizing that there are a wide range of roads they can take to achieve said goal. Needless to say, each road/option comes with its own risk factor and no matter which one you end up going with, there are pros as well as cons to take into consideration.

Risk-averse individuals might decide that as far as they are concerned, “accumulation” is the name of the game and as such, will probably opt for strategies such as investing in legitimate Chinese companies (for example, one of the roughly 100 NASDAQ-listed Chinese businesses) in a buy and hold manner. Or, to use trading terminology, we can call them position traders, traders who don’t feel the need to constantly enter/exit the market and instead, have no problems whatsoever holding positions for even multiple years.

The pros associated with such approaches tend to revolve around risk minimization, whereas the cons tend to revolve around the fact that returns will most likely be less than spectacular compared to let’s say success stories involving more aggressive methods. To put it differently, the likelihood of “hitting it big” overnight by simply buying and holding NASDAQ-listed Chinese company shares and not using leverage at all (not “borrowing” capital from your broker so as to invest, in other words) is quite low.

In contrast to such approaches, we have risk-tolerant traders who don’t mind engaging in many more trades and, also, using leverage so as to increase their return potential. For example, it is possible to put a mere $x on the table and control a $10x or $20x position by essentially borrowing funds from your broker. Needless to say, your profit-generation potential goes up exponentially but… well, so does the downside potential. To put it differently, the share you’ve invested in would need to literally go to zero for you to lose your capital as a buy and hold trader who doesn’t use leverage at all. On the opposite end of the spectrum, a single-digit price decrease can be enough to wipe out those who use let’s say double-digit leverage. As such, of course those who end up “winning” have a lot more to show than your average position trader but only looking at winners represents a form of survivorship bias, with traders who do this failing to understand that for every leveraged trading success story, there are multiple loss stories that oftentimes end up ignored.

Why?

For many reasons, which range from reasons related to the traders (gamblers, in many cases) themselves, who love bragging about winning streaks but keep quiet when losing money to reasons pertaining to brokers, who don’t exactly want to highlight the negatives associated with leveraged trading for obvious reasons. Fortunately for consumers, the FTC over in the United States and similar entities in other jurisdictions frequently force brokers to reveal statistics related to the percentage of retail traders who lose money in the banners and other creatives they use. As such, if you look closely enough, you will observe that fine print sentences such as “Over 75% of retail traders lose money” are a common occurrence because indeed, study after study proves that the average retail trader ends up losing money.

This reality is easy enough to research and even more so, as explained previously, statistics are even mentioned in promotional materials (primarily because advertisers are compelled by the law and/or the self-governance of the ad platforms themselves to provide such data) used by brokers. Why, then, do so many people still fail to assess risk properly?

A one-word explanation for this would be “greed” or in other words, the fact that their judgment is clouded by dreams of overnight success. Another one would be “ego” or the fact that most people, after reading the less than optimistic statistics pertaining to retail trading, end up believing they are somehow special and will therefore be on the other side of the fence… reasons abound.

What would the ChinaFund.com team recommend?

Right off the bat, we want to make it clear that if you as a trader don’t have a so-called edge (or alpha, to use trading terminology), the odds are HEAVILY stacked against you when it comes to margin trading. Therefore, we would strongly recommend staying far, far away from leverage because more likely than not, you do not have any kind of meaningful edge over professionals.

Even if you do have a legitimate edge, doing well in the long run as a trader who uses leverage is easier said than done, and your alpha most likely has an expiration date that is closer to the present than you would care to admit.

Accumulation, accumulation, accumulation!

In our view, the best approach for the overwhelming majority of individuals who are reading this article revolves around identifying worthwhile Chinese assets and making long-term accumulation their #1 goal. No need to use leverage, nor is it required to enter and exit positions on a daily basis. On the contrary, accumulation-oriented strategies should be as “boring” as humanly possible because at the end of the day, your wealth is on the line and thrills are best left for endeavors not related to your financial future.

If you do choose to use leverage, keep it on the low side, proceed with extreme caution and understand how to play the risk management game properly, a dimension arguably even more important than “getting it right” price action-wise (contrary to what the average trader believes). Of course, no matter which strategy you and/or your organization end up choosing, the ChinaFund.com team is at your disposal if you would like to pick the brains of our experts. While we do not offer to manage money on behalf of clients, we are more than happy to be of assistance with… well, pretty much anything else and are only a message away.