Thursday, July 24, 2008

Excessive Leverage: How they destroy

Lazard CEO says Wall St leverage fueled bubble
Lazard Ltd Chairman and Chief Executive Bruce Wasserstein said on Wednesday many of the financial market's current woes stem from years of too much risk-taking and not enough common sense among Wall Street executives. The famed deal maker told a Wall Street Journal-sponsored gathering of reporters and industry executives that, in recent years, broker-dealers had increased their leverage, or total assets relative to equity, to excessive levels.

In India, Stock Futures offer a 1:10 leverage, sometimes even more. Worse, many brokers trade in these instruments (proprietary trading).
Excessive leverage is financial suicide. This mesage has come clearly from all corners of the world in the year 2008 financial meltdown. Yet, stock futures with their killing leverage are offered to an unsuspecting middle class to 'gamble' with.
As a trader, understanding leverage is the most important part of your trading plan. If you have Rs 100, and you are trading in Rs 150 worth of securities, then your leverage is 1.5. With this kind of leverage, and just a little bit of common sense, you can make a profitable career in trading.
On the other hand, you have Rs 100/- . Now you can trade in financial weapons of mass destruction called stock futures which are offered to all middle class Indians with a leverage that can extend to 10 times your investment. So, you trade in Rs 1000/- worth of stock futures. This is financial suicide with a guarantee - meaning you will get exterminated, financially.
Stock Futures as 25% of all trading volume, are not used in any country except India. Why ? Are all other countries fools ? The answer is: Every other country protects its citizens from the evils of gambling. Since stock futures are just gambling and not much else, these are not allowed / encouraged, except in India.