In its most recent report, the analytical firm Ecoinometrics compares the return of bitcoin with the returns of the main traditional assets, in a scenario in which it tries to double the investment in one year with each asset.
Given that the annual returns of most traditional assets are reduced to single digits, according to Ecoinometrics, the study analyzes the leverage required by these assets, to achieve the objective of obtaining a return of 100% in 12 months.
What is leverage?
Leverage in the stock market is basically the use of a loan to increase the amount invested in a certain asset. Zacks Investment Research defines it as follows.
The basic concept of leverage in the stock market, also called margin trading, involves borrowing capital to invest in more stocks than an investor can afford on his own. Stock market leverage can result in an increase in your return on investment, but it can also lead to losing more money than buying stocks using only your own funds.
Zacks Investment Research
For hedge funds, the U.S. Securities and Exchange Commission (SEC) have established specific requirements that regulate the practice of leverage, Zacks notes. For example, the investor must keep at least 25% of the value of his purchased shares in his margin account at all times.
“If the value of your securities falls substantially, the brokerage firm may issue a margin call, requiring you to repay all or part of your loan,” Zacks notes.
Brokerage firms and investment banks sometimes set their own rules regarding margin accounts, Zacks says. “In the case of a margin call, the brokerage firm does not need permission from the investor to sell a portion of the financial securities in his account.”
The latter occurred in the case of some of the banks that had provided large leverages to Archegos, the US hedge fund that collapsed when leveraged stocks depreciated, as we reported in this publication.
Calculating how much leverage is necessary
If the objective is to double the return on investment of an asset in a year, it is necessary to know the estimate of its annual return, the study points out. For example, NASDAQ’s annual return estimate is 20%, based on historical returns over the past 10 years, says Ecoinometrics. The latter implies that 5X leverage is required to double the investment in one year.