It is now the afternoon of January 24, 2026.
A topic not explored in depth in the previous draft of The Protracted War of Capital is leverage.
Leverage is an unavoidable objective reality. Moreover, leverage is ubiquitous; it does not disappear due to subjective human will and cannot be avoided.
People often think that "using leverage" is an extremely risky endeavor. In fact, it is similar to vehicle speed—it is not inherently dangerous; the danger lies in people's inability to control it.
Not participating in the market means zero leverage. Partial participation means a leverage ratio of less than 1. Going all in without borrowing means a leverage ratio equal to 1. Participating in the market with borrowed funds means a leverage ratio greater than 1. For now, the natural domain of leverage is non-negative real numbers.
In reality, it can also be negative, such as in short selling. Thus, the domain of leverage becomes the entire set of real numbers.
Regardless of whether individuals believe they are using leverage, leverage is at work. This point is often overlooked.
Next question: What is the relationship between leverage and volatility?
The mathematical essence of volatility and leverage is consistent.
For example, consider an asset with a daily volatility of 1% but accessible with 10x leverage, versus an asset with a daily volatility of 10% but only accessible with 1x leverage. They are mathematically equivalent because the effect of leverage can be linearly transformed into the effect on price, which in turn linearly determines the effect of volatility. Readers are encouraged to ponder this carefully.
The strategic space available to traders in these two assets is completely equivalent.
Therefore, by Occam's razor, leverage can be reduced to volatility.
In markets with higher volatility, the victories depicted in The Protracted War of Capital are easier to achieve.
On-Exchange Leverage vs. Off-Exchange Leverage
- On-exchange leverage refers to trading using leverage tools provided by exchanges, such as margin trading, futures contracts, etc. There is typically no interest cost.
- Off-exchange leverage refers to leverage obtained through borrowing, financing, etc. It usually involves interest costs, but there may be risk transfer methods to mitigate the risks of high leverage.
On-exchange leverage is generally easier to access and use but is limited by exchange rules and restrictions. Off-exchange leverage is more flexible but requires consideration of borrowing costs and risk management.
By utilizing a comprehensive leverage strategy, higher capital efficiency and risk-adjusted returns can be achieved.
The Leverage Nature of Funds
In traditional markets, professional investors attempt to obtain off-exchange leverage by launching funds.
Typically, investors bear the risk of fund losses themselves, while managers of private funds usually demand 20%-30% of excess performance (industry norms require no more than 60%) as a performance fee.
Taking a 20% performance fee as an example, the manager essentially obtains 20% of risk-free raised capital as leverage for free. For instance, if the manager invests 1 million of their own capital and the total fundraising amount is 100 million, it is equivalent to the manager investing 21 million, resulting in an off-exchange leverage ratio of 21x. If on-exchange leverage (e.g., 5x) is added, the total leverage ratio would reach an astonishing 105x. Factoring in the market's inherent volatility (e.g., 5% daily volatility), the equivalent daily volatility would be 525%, meaning the asset's fluctuation range within a day would be an astounding 5.25 times.
Based on the manager's own capital of 1 million, in such an ordinary market, the manager's daily profit or loss fluctuation would reach 5.25 million. This demonstrates the immense power of leverage.
Leverage-adjusted market volatility = Market Volatility × On-Exchange Leverage Ratio × Off-Exchange Leverage Ratio
Among these, market volatility and on-exchange leverage ratio typically have little to do with the individual, while the off-exchange leverage ratio is the leverage that an individual can fully grasp.
The Cost of Off-Exchange Leverage
Using off-exchange leverage requires paying direct costs, mainly including:
- Interest Cost: Borrowed funds usually require interest payments, which reduces the overall rate of return.
- Performance Cost: As mentioned earlier, fund managers typically demand a performance fee, which is equivalent to giving up a portion of the profits.
These are two-dimensional costs: the interest cost that accumulates over time, and the performance cost that grows with profits. Interest must be paid rigidly, while the performance cost can share risks with the financing party. This is also why professional fund managers prefer to obtain leverage through performance fees rather than through borrowing.
However, in my view, the market's inherent volatility multiplied by on-exchange leverage is often sufficient. Individuals also have another way to obtain leverage, namely the "pyramiding" strategy, which has already been mentioned in The Protracted War of Capital.
In the manner described in The Protracted War of Capital, the future form of funds may be more about providing psychological comfort to fellow participants rather than serving as a practical means of obtaining leverage.
