[smabie]

Leverage allows the execution of strategies that have a high Sharpe but low natural return.

I work at a small prop trading firm and we run 10x or even more leverage most of the time. Without leverage, we wouldn't be able to run the vast majority of our strategies.

Basically, leverage is immaterial: what matters is the risk of the strategy. A leveraged strategy could be less risky than an unleveraged one.

Things that you should consider when deciding leverage: beta exposure, correlation to the market, volatility of the strategy, and the risk adjusted return of the strategy.

A classic example of this is risk parity: risk parity uses high leverage but is often safer than a classic 60/40 portfolio.

[fairity]

To be honest, what you just said went right over my head, but I really want to learn more. Can you recommend where to start given that the strategy I'm evaluating is akin to levering up 1x and investing in index funds?

[smabie]

I have a blog post I wrote awhile ago that might be of interest:

Diversification, Risk and Leverage https://cryptm.org/posts/2019/11/28/div.html

If I was rewriting the post today, I would make some changes, but by and large, I stand by the post.

[ptsneves]

@smabie: Thanks a lot for the post. I am for the first time understanding concepts that in words were very hard to process. The math connection you make really helps, as basic calculus as statistics are part of an engineering background.

[smabie]

I really appreciate it! Finance can be a really opaque topic and there's a lack of rigorous yet straightforward material about the subject.

Most information about trading either falls into the total bullshit camp designed for idiot retail investors, or complex papers/books designed for academics or professionals.

My blog tries to straddle the two: providing rigorous material but geared to those without a background in finance.