Diminishing Returns with Leverage

rgd · Post by **rgd** » Mon May 03, 2010 2:21 pm

I have noticed that there are diminishing returns when increasing leverage. Conceptually, if you employ 100% of equity, and then 200%, it would stand to reason all performance metrics would double, but that is not the case. Before I go on a solitary, multi-day excursion searching for the relationships which cause this observation, I was hoping someone can get me started in the right direction, or even explain why this is the case!

Be kind, don't make me look too stupid!

LeviF · Post by **LeviF** » Mon May 03, 2010 2:31 pm

If you are talking stocks, cost of margin would be one component.

rgd · Post by **rgd** » Mon May 03, 2010 2:47 pm

Does that explain the entire difference? Has anyone checked into this?

Anyway, in my example, I was using futures and simply multiplying my initial bet size * 2. The relationship is not linear, and the incremental return is less than 2x. I have earn interest turned off.

LeviF · Post by **LeviF** » Mon May 03, 2010 2:52 pm

Are you getting the same number of trades on each run? Available margin and volume considerations may be coming into effect.

rgd · Post by **rgd** » Mon May 03, 2010 4:06 pm

I have disabled volume and margin.

The Kelly formula shows the optimal bet size for the system to be 26%, for each individual market that would be a certain death strategy. However, I do find optimal total portfolio risk to be in that general area.

I assume the reason is when you cross the optimal threshold, overcoming drawdowns becomes increasingly difficult. If anyone has more insights, I would love to hear them.

sluggo · Post by **sluggo** » Mon May 03, 2010 5:39 pm

Maybe the system experiment supplied in THIS thread, and the associated graph, might be what you're looking for.