Leverage is a great tool for traders to control even larger positions at smaller costs that can increase their profits even more. On the other side of the coin, leverage really raises risks, and thus an effective management of leveraged trades is essential to avoid huge losses.
The major risk associated with leverage is that it magnifies losses just as much as gains. In volatile markets even small price movements quickly start eroding a trader's account with high levels of leverage. Effective stop-loss levels should be set to manage this risk. A stop-loss order closes the trade at a predetermined price in order to limit any possible losses and safeguard the capital of the trader.
Position sizing is another critical factor in the management of leverage. Each position size must be consistent with the risk capacity of the trader, for example, limiting risk at small percentages of total capital, commonly, 1-2% per trade.
Monitoring the margin requirements is as important as position sizing. The reason is that most leveraged trades are conducted in margin accounts; when the balance goes below the margin requirement, a margin call occurs and forces the trader to either remit additional funds into the account or close out positions at a loss.
Ultimately, leverage always will be available in high-stakes circumstances, thoroughly investigated, and most probably proven ones. Thus the risks that are not needed would be avoided altogether. Accordingly, disciplined and careful risk management would help traders take leveraged trades while lessening the downsides.
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~ Nesaty