The availability of leverage is, to use the most cliché of clichés, both a blessing and a curse. On the one hand, the profit maximization potential is most definitely undeniable, with fortunes having been made time and time again by trading Chinese assets or any asset class for that matter using leverage. Unfortunately, it’s not exactly all sunshine and rainbows in the oftentimes murky and depressing world of leverage.
A lot of investors who live by leverage… well, die by leverage.
More specifically, leverage comes with its share of trade-offs, with them for the most part revolving around the idea that while profits are or better stated can be amplified via leverage, the exact same principle is valid with respect to losses. The icing on the cake, in the most negative sense imaginable, is the fact that unlike with simply buying and holding, leveraged trading comes with the very real and palpable risk of liquidation.
Let us assume an investor buys one of the several NASDAQ-listed Chinese company shares without leverage. Is losing everything he invested possible in the scenario in question? Yes, but it represents a remarkably low-probability event. Of course it can happen if let’s say the company in question goes bankrupt but in the absence of a genuinely “end of the world as we know it” scenario for the company in question, losing it all is quite unlikely.
This leads to many “rags to riches” success stories. For example, back in the day, Amazon shares went from $100 during the peak of the Dot-Com Bubble to around $7 each after it burst. In other words, an investor who bought at the absolute worst possible moment during the bubble and was equally unlucky when selling would have only received 7% of the money he allocated back. Those who didn’t sell because they believed in the long-term potential of the company, however, didn’t realize any losses and on the contrary, even the unluckiest of investors when it came to the acquisition timing dimension (buying during the top of the Dot-Com Bubble, for example) did remarkably well if they held up until this point.
That changes dramatically when using leverage.
To remain in Amazon territory, the person in our example, who bought shares at the worst possible time, would have been liquidated even with ultra-low 2x leverage well before the $7 price was hit. Let’s not even talk about those who engage in leveraged trading we can consider in gambling territory and who are liquidated by movements in the opposite direction of even 1% or less.
Isn’t it true that those who backed up the truck and bought at $7 were on the receiving end of novel-worthy gains? Of course, just like those who bought bitcoin for literally pennies ended up becoming extremely wealthy or just like those who “invested” in a lottery ticket and won did the same. But such scenarios are such extreme low-probability events that taking them into consideration when making choices that pertain to your career as a trader is anything but recommended. To put it differently, examples involving individuals who “invested” their one-month earnings in lottery tickets or equivalents and won surely exist. Does that mean investing your one-month earnings that way represents a strategy worth taking into consideration? Of course not.
How much leverage, if any, you use should depend on the volatility of the asset in question. Those who trade “boring” forex pairs are far safer when using leverage than those trading let’s say cryptocurrencies. For example, even the proverbial king of cryptocurrencies, bitcoin, ended up going up by 40% within roughly 24 hours as of the 27th of October 2019. The same way, it collapsed by more than 50% within the same 24-hour period as of the 20th of March 2020. Needless to say, using serious leverage when trading even the “safest” of cryptocurrencies tends to be closer to gambling than investing.
The volatility differences from asset class to asset class and asset to asset can be so wild that the ChinaFund.com team can most definitely not provide a “one size fits all” answer with respect to questions involving how much leverage should be used or even if leverage should be used at all. It ultimately all depends on the nature of the asset(s) you are interested in trading as well as on your risk appetite as a trader.
Are Chinese assets volatile?
Once again, the answer is that… well, it depends.
First and foremost, it depends on which Chinese asset you are referring to, as they tend to let’s say come in all shapes and sizes. As such, a Chinese asset that trades on a legitimate exchange such as the NASDAQ will likely be less volatile than one you buy/sell via obscure OTC exchanges. Furthermore, a lot also depends on your frame of reference or, if you will, what you are comparing the Chinese asset you are interested in to. Compare the overwhelming majority of Chinese assets to one of the literally thousands upon thousands of random low-liquidity altcoins (bitcoin alternatives, as the name suggests) that exist and the Chinese assets in question will most likely seem like the epitome of safety. Compare them to “the best of the best” in terms of US safe haven assets and the exact opposite conclusion will be drawn. Again, it all depends on your frame of reference.
As a conclusion, leverage is yet another example of something that is neither good nor bad, just like a knife isn’t inherently good/bad either. It is simply a tool and as such, it all depends on how it is used. A knife can be used by a surgeon to save a life or by a criminal to take one and the exact principle is valid with respect to leverage. Is it worth having in your arsenal as a Chinese asset trader? Most definitely but “prudence” is the operative word!