Leverage and Volatility

Suppose a trader predicts a given stock to rise by 25% over the next 10 days. Of course, if he is unleveraged, if the stock does indeed rise by 25% in 10 days, his 10-day return will be 25% irrespective of how volatile the stock price was in the interim. This, however, is far from true were he leveraged (i.e.trading on margin, as opposed to trading unleveraged while taking outside loan for providing capital). If he was 300% leveraged, then his return at the end of 10 days, is far from 100% (4 times 25%) as one would naively imagine, but a devastating -47%, in the volatile scenario 1. It is only in the non-volatile scenario 2 that leverage actually multiplied his returns.