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While looking at different C2 systems I found a metric called “leverage”.
In the description it says :
“Collective2 calculates the maximum leverage used by a strategy in each day.
Example of calculation:
The Strategy buys 100 shares of stock at $12 per share.
The Model Account equity during that day is $5,000.
The leverage is: $1200 / $5,000 = 0.24”

Not sure if I understand correctly but isn’t the leverage zero in this case, since the trader is not buying on margin (he is paying full price for the stocks)?
If it costs me $1200 to buy 100 shares of a $12 stock, where is the leverage?
Any comment would be appreciated , thanks (sorry if this question has already been answered elsewhere).

I’m just using what I’ve noticed with my strategy as a guide. Think of a leverage rating of 1 as 100% of your account is invested in a non-leveraged equity at all times. If your account equity was $5,000 and you bought 100 shares of SPY at $12 then your leverage would be 0.24. But, if you bought 100 shares of UPRO at $12 then your leverage would be 0.73, because UPRO is triple leveraged.

It’s a little smarter than just calculating margin based on borrowing the way a broker would. This gives an easier way to find strategies that martingale by leveraging up as the market moves against them and those that use dangerous amounts leverage while trading futures or forex.

Thank you for your reply EthosPortfolio.
I think the problem comes from the definition of leverage. In trading (and the financial world in general), leverage is simply the use of debt in order to acquire a financial asset. In other words it is simply a loan from our broker (or banker).

For instance if I can buy 100 000 Euros with only 1 000 Euros down (margin money), my leverage is 100 to 1. This 100 to 1 leverage is set by the broker and cannot vary from day to day, it is a given. So I simply cannot understand how this leverage can be re-calculated every single day.

If the trader had bought an unleveraged asset - say a stock- with its full capital then the leverage is 1. In this example if he had bought ~417 shares then C2’s leverage metric would be computed as 1. So the example computation is correct.

I disagree with that definition. I would say that is more the definition of margin. Leverage can also be using financial instruments (futures, options, etc.) to act in the same way as margin, ie. instead of borrowing 2/3 of the capital to buy SPY I can buy UPRO instead and have the same effect. There’s no margin involved in buying UPRO in that transaction but I’m definitely leveraged the same as if I bought SPY with only 1/3 of the capital. I’ve always thought of it as “not all leverage is margin but all margin is leverage.” Leverage is the outcome of using margin, but there are different ways to achieve leverage.

That’s the official definition given by Investopedia (the “wikipedia” of the financial world).
By the way, in the futures market you are also “borrowing” money from your broker. Every time you are controlling large positions (say 200 tons of soybeans) with a small capital your broker is the one loaning you the money (even if it does not appear that way).
And you are right about leveraged ETF, even though these financial instruments are relatively new.

Leverage and risk should be based on volatility, not the absolute value of the shares of stock or futures contract. For instance, $10,000 invested in SPY or ES Futures is much more leveraged today than it was two months ago, even though the value of the contract is less. The daily volatility of Crude oil is now about 6% while the British Pound is 0.6%. That is why futures margins are based on volatility, not absolute value of the contracts, and are adjusted as markets change. Stocks are more one size fits all.

How can we say that a strategy is “risky” because it uses “too much” leverage if each trader has his own definition of the word leverage? And again, how do we calculate that leverage exactly, in that case?
See the problem here?

That said, in its traditional definition and as far as trading is concerned:
Leverage is an investment strategy of using borrowed money—specifically, the use of various financial instruments or borrowed capital —to increase the potential return of an investment. (Investopedia).
Please note that the starting capital is never mentioned here and has nothing to do with the way leverage is calculated : If I can control/buy 100 000 euros with only 1000 euros my leverage is 100 to 1, period, regardless of how much money I have in my trading account.

So by definition we cannot say that strategy XYX is “risky” because it uses “too much” leverage, we can only say that it is risky because the system developer routinely allows losing trades to eat a large portion of his trading capital, percentage-wise.

In other words the trader cannot control the leverage (it is set by his broker), he can only control the percentage of capital he is willing to risk on each trade (via the stop).

But let’s go back to the C2 calculation. We will use strategy A and B, from two different system developers :
Strategy A buys 100 shares of stock at $12 per share.
The Model Account equity during that day is $5,000.
The leverage is: $1200 / $5,000 = 0.24

Strategy B buys 100 shares of stock at $50 per share.
The Model Account equity during that day is $50,000.
The leverage is: $5000 / $50,000 = 0.10

Now, is strategy B really less “risky” simply because its “leverage” is much smaller ?

That is the definition they give, but then in that article they qualify it by using the term “margin based leverage”. Inside a tripled levered ETF the manager is using futures which, as you said, is margin and leverage. C2 simply chooses to include the margin within an ETF in their calculation of leverage. That makes the stat much more informative than just margin, which C2 also details.

I don’t really want to debate you on how should C2 calculate leverage, I’m simply explaining how they do calculate it.

The C2 leverage metric is calculated for every C2 strategy, no matter what financial instrument the trade leader is using (stocks, futures. Forex…).

My question (see post above) is very simple, here it is again :
Trader A has $5000 in his trading account. He buys 100 shares of a $12 stock. According to C2 the leverage is 0.24.
Ok, fine.
Trader B buys 100 shares of a $50 stock and he has $50K in his trading account. According to C2 his leverage is 0.10
Ok, fine.

Now, how can we possibly conclude that the strategy of trader B is less risky simply because his “leverage” is smaller ?

I did not say it wasn’t calculated for each strategy. I’m just using leveraged ETFs as an example.

You didn’t include risk in your original question. Leverage is just one factor in determining risk. Trader A MAY BE more risky because they are putting a higher proportion of their capital to work. Its not the only someone should use. An investor should look at a number of stats to determine risk including leverage and style of trading.

How would calculating leverage by only using margin be more useful for C2 investors in determining a strategy’s risk?

Your risk is your stop, nothing else, it has absolutely nothing to do with the percentage of capital we allocate to a particular trade.
(FOMC in less than a minute, let’s see…)

“How would calculating leverage by only using margin be more useful for C2 investors in determining a strategy’s risk?”

In my opinion the average daily drawdown (or the average drawdown after each completed trade) of each C2 system would be a more useful metric.

Your risk is your stop, but that’s not the strategy’s risk and the risk to other subscribers. At the very least the leverage number can help forecast how quickly you will hit your stop loss if things go against the strategy, ie a leverage of 3 will cause you to hit your stop loss 3 times faster that a leverage of 1.

A DD number is also useful but that’s in the past. If a trader suddenly leveraged up (like a martingale system) a DD number wouldn’t help in showing the increased risk the strategy is taking on. There is nothing wrong with how C2 calculates this. If you like to use other metrics then they are also available for your use.

All things being equal, a 2% stop (for instance) will not get hit “faster”, no matter how much % of capital you are allocation to a particular position (what C2 calls leverage). Again, the risk is the stop (in percentage), not the capital you decide to put on a trade versus total trading capital.

“A DD number is also useful but that’s in the past. If a trader suddenly leveraged up (like a martingale system) a DD number wouldn’t help in showing the increased risk the strategy is taking on”

If the trader is averaging down via a martingale the subscribers will immediately notice and take the appropriate measures (or not).
More importantly, I can show you a few C2 strategies with extremely low “leverage” (as measured by C2 calculation) but when you inspect the track record you find 30% or more drawdown on a single trade.

By the way, what is a “good” leverage number in your opinion, as far as C2 strategies are concerned?

“There is nothing wrong with how C2 calculates this”
I never said that at all, we are just trying to determine the value of that metric (leverage) as a measure of risk.

This is only true if the leverage metric is under 1. If it’s over 1 then the strategy is using leverage and your 2% stop will get hit faster - and that’s risk. Luckily C2 has an easy way to quickly determine if a strategy uses leverage

“ If the trader is averaging down via a martingale the subscribers will immediately notice ”

They might, but C2’s leverage number also makes it easy to visually find martingale systems, even if the trades are being hidden. Simply turn on the leverage overlay on their performance chart. If leverage goes up while their account equity goes down - boom - probably martingale.

“ More importantly, I can show you a few C2 strategies with extremely low “leverage” (as measured by C2 calculation) but when you inspect the track record you find 30% or more drawdown on a single trade.”

I specifically said leverage isn’t the only factor in determining if a strategy will fail. It’s an important metric through.

“ By the way, what is a “good” leverage number in your opinion, as far as C2 strategies are concerned?”

Depends on what you’re trading, your style and your risk tolerance. Like all trading there is no one size fits all.