The recent Robinhood scandal is a sobering tale: you can blow up your account — or worse — using leverage. And it can happen all too fast.
Imagine you find a glitch with your broker where you can buy as many shares of a stock as you like. Would you take advantage of it?
This exact situation happened recently, and it’s been quite a scandal. And there are important lessons here…
Read on to catch up on what happened and learn about the very real dangers of using leverage in your trading. Plus, we’ll cover specific, practical strategies to help you trade intelligently and improve your skillset.
We’ll also talk about the effect that joining a trading community like StocksToTrade Pro can have on your trading journey…
Let’s jump in!
Table of Contents
The Robinhood Fiasco: What Happened?
In the past couple of months, a small group of crafty-yet-foolish Robinhood customers realized that they could manipulate the trading app to obtain seemingly unlimited leverage through the use of options and margin.
These customers used this leverage to effectively gamble huge amounts of money on stock movements, while only having a small amount of funds in their account.
One user was able to deposit $3,000 and build to a position of over $1.7 million. It was absolute insanity, and there are many similar stories.
These users tended to congregate on Reddit, an online forum website, where they would encourage each other’s foolishness.
One of these users was recording himself as the market opened, while he held a highly leveraged position in Apple stock options…
In the video, you can watch as the customer loses more than $40,000 in just seconds — with only $2,000 in his account. You see the second he realizes things didn’t go as he planned as he makes a bone-chilling ‘guh’ sound. Don’t be that guy!
If you’ve been around the markets for any time at all, you’ll know that absolutely everyone has both winning trades and losing trades. You have to learn to manage your risk accordingly.
By using the Robinhood glitch to take such huge leveraged positions, these customers opened themselves up to losing huge amounts of money and potentially bankrupting themselves.
Who’s to blame? Did Robinhood err in constructing their program in such a way that allowed for the glitch? Or … is it on the customers who used the glitch to take such a risky position?
OK, this post isn’t about playing the blame game … Instead, here are some thoughts on why you should be extremely cautious with leverage and why you shouldn’t necessarily follow the herd … Especially if it involves doing something that could be financially catastrophic.
There’s an old saying in the markets: “There are old traders … there are bold traders, but there are no old, bold traders.”
That means that if you want to survive and thrive for a long time in the markets, you need to protect yourself and your capital, and not be a gung-ho risk-taker.
Let’s explore this a little further…
What Is Leverage, Exactly?
I don’t want to get into a deep discussion about leverage without you being completely clear about what it is…
Leverage in the stock market is where you borrow shares from your broker to increase your position size in a trade.
For example, let’s say you have a broker that allows you to trade a stock on a 50% margin. So you have $500 and purchase $1,000 worth of stocks.
Leverage is also found in futures, forex, and options contracts. With those products, you’re not borrowing from your broker. You’re putting up a margin to the exchange, which allows you to take a larger position size.
Leverage isn’t only found in the financial markets though…
For instance, when you buy an investment property using a mortgage, you might be putting down a $100,000 deposit to purchase a $500,000 house. That mortgage is a form of leverage.
Leverage is basically going into debt to own more of the asset you’re trading.
Via Shutterstock (ID: 1369041242)
The Dangers of Leverage
Warren Buffett, one of the most successful investors of all time has been quoted that there are three ways to go broke: “liquor, ladies, and leverage.”
To the inexperienced trader or investor, leverage can be a very enticing trap. It can trick the newbie into thinking they can make big money fast and easy — starting out with just a small amount of capital.
In fact, it’s not just newbies who can fall into this trap. Experienced traders have also been known to do stupid things with leverage. In the past, we’ve seen major hedge funds go bust using it. Even billionaires misuse it and go broke.
Leverage can increase the size of your wins — as well as your losses.
Furthermore, if your leveraged position goes against you more than your initial margin, you can be asked to deposit more funds or even end up owing your broker money.
In general, many of my trader friends and I are against leverage. There’s simply not a real need for it.
Having a long, successful trading career is about managing your risk, staying in the game, and continually taking good trades.
With penny stocks, you can often find a handful of tickers that move 20%, 30%, 50% or more in a single session. If you concentrate on catching those kinds of moves, there’s no need to complicate things by adding leverage.
One of the main reasons the risk-taking Robinhood customers got themselves into trouble is that they were sucked in by the potential profits they could make. But they didn’t stop to consider just how much they could lose if their positions went against them.
That was exacerbated by the fact that some of these traders encouraged each other to do stupid things with their accounts. And that brings me to the topic of the benefits and dangers of being a part of a trading community…
Trading Communities: The Good and Bad
Without a doubt, trading can be a lonely business.
You have so much to deal with each day:
- Finding trading opportunities
- Constantly changing stock prices
- Making rapid decisions
- Refining your trading strategies
- Keeping your cool as you grapple with winning and losing trades
On top of that, many of us are sitting at home, alone, in front of our screens all day.
That’s why it can be a tremendous benefit to join a trading community, whether in person or online. It’s a way to interact and share your journey with other traders…
But be warned: not all trader communities are equal. A lot of trader communities and forums are filled with losing traders who spread terrible advice and encourage bad trading habits.
The Reddit community those Robinhood customers were a part of was one of the bad communities. In that community, we saw the members turn the activity of trading stocks into a form of gambling similar to horse or sports betting.
Here’s my advice to you … if you want to gamble, go and have a few drinks while you play roulette. You’ll have a better time while losing your money.
Via Shutterstock (ID: 590533223)
A smarter approach to the markets should be more along the lines of part scientist, part business operator.
You want to have a strategy that works, a plan to manage your risk and a changing market, and a way to develop your skillset. And you should always want to be in control of yourself and your trades.
In other words, you want to treat trading as a business — because it’s a serious business.
So, if you’re going to join a trading community, make sure you join one where your fellow members also treat trading like a business.
That’s exactly how we approach the markets in StocksToTrade Pro, our elite trader community.
Inside StocksToTrade Pro, you’ll be one of our team of traders who participate throughout the day in our chat room. You’ll have access to me throughout the day. You can see my trading screens and hear my thoughts on the markets. Plus you’ll have the chance to attend regular trader education webinars where I share cutting-edge trading tactics.
If you’re ready to step up your trading and approach it as a business, join StocksToTrade Pro today!
Smart Traders Use StocksToTrade
Some of the world’s best stock traders use our trading platform, StocksToTrade.
There’s a solid reason we’re so popular with elite traders … The team that created the StocksToTrade platform isn’t a bunch of nerdy accountants, marketers, or business people. They’re REAL traders who know what REAL traders need.
We put a huge amount of time and money into developing StocksToTrade. We’ve designed it to be a one-stop-shop solution that allows traders to have just about everything they need in one piece of software.
I’m talking charts, scanners, news feeds, algorithmic trading, watchlists, broker integration, and so much more…
If you want to take your trading seriously and treat it like a business, grab your 14-day trial of StocksToTrade for just $7 and use what professional traders use.
Conclusion
The main lesson to learn from the Robinhood unlimited leverage scandal is that nothing comes for free.
The traders who took advantage of this loophole were trading recklessly, thinking only about the potential for profits. They didn’t consider the enormous risks they were taking.
Before taking any trade — or entering into any kind of business deal — the first thing you should do is consider the risk. Good trading is careful trading.
If you ever find a similar loophole with your broker, please don’t use it. It’s a foolish path to take, and you can lose so much so fast.
Instead, build a long and successful trading career by following a trading strategy that works. Learn how to manage your risk and slowly build your account.
That’s exactly what we teach our traders to do in the StocksToTrade Pro community.
Start improving your trading skills now. See how professional traders attack the market every day and interact with other traders … and join StocksToTrade Pro today!
I consider myself lucky to be surrounded by clever, positive-minded traders. What’s your trading community like? Tell me in the comments below!