In the absence of transaction costs, the leverage you use has no impact on your probability of success. If you were to place trades randomly, without any particular insight or skill, and aim to take profits of the same size as your maximum stop loss, you’d tend to win on 50% of trades and lose on 50% trades.
This would be independent of your leverage used, and is represented by the dotted horizontal line on the chart.
Transaction costs change this picture, representing a hurdle between you and a profitable trade. Another way of saying this is that costs shift the odds against you. At most levels of leverage this shift in odds is small.
However, when the leverage you use is so high that the margin supporting your trade is less than 10x to 20x your costs, your probability of losing begins to increase very rapidly.
This is because costs eat away at the supporting margin, leading to a high probability of being closed out. This is easy to understand if you think about the most extreme case, where your supporting margin is exactly equal to your transaction costs on a trade. You’d place your trade, and the transaction costs would leave you with zero supporting margin for your position. This would lead to you being closed out immediately, with 100% probability, every single time – regardless of your trading strategy or how the market moves.
