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Leverage increases profits exponentially. Here, for example, a leverage multiple of 4 more than triples expected gains per year and increases cumulative gains more than five times over the test period.

But here's the catch. At five and beyond, you enter nosebleed territory. Drawdowns start to exceed 50%. These are very difficult pysychological 'loss' levels to tolerate, especially when you have bought your position at the top of the peak before the drawdown.

Leverage crests at 7 times. Beyond that, the favorable impact on ballooning profits starts to diminish vigorously, and drawdowns swing into very high double digits. Beyond leverage 12, you are busted, ruined, killed, game over.

As mentioned elsewhere, this region is off limits for most. Some of the best brains in the world have gotten financially killed here (using reported leverage levels in excess of 100--"whom the gods would destroy, they first make mad"). Some of the strongest-stomached, boldest-hearted, super-confident, hedge-fund operators have been murdered here--and buried, some with great fanfare, some unceremoniously, by the banks and the public.

Oh, by the way, you get here using derivatives. Mostly options, futures, and swaps.

See Explanatory Notes


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