What is Leverage in Trading?
Leverage is one of the most powerful tools in trading. You can use it to take advantage of small price fluctuations, or use your portfolio to gain greater exposure or better returns on capital.
Trading with this tool can significantly increase your profits, without having to invest a large sum of initial capital.
Trading with financial leverage means trading with more money than available funds. To carry out these transactions, the broker grants a temporary loan to the trader so that he can trade with a position larger than the amount of funds in his account.
To express leverage, a multiplier is often used, which shows how many times the amount of an open position is compared to the trader's actual amount of funds used in that position.
The idea of this method is to use additional capital to buy more contracts for the asset, with the expectation that the return on the position will be greater than the cost of borrowing.
However, just as leverage can increase potential returns, it also increases exposure to risk. It is therefore used by experienced traders.
The advantages leverage offers are obvious: - It minimises the capital required to invest. E.g. You only need to have $80 in account capital to make a trade of $16,000. - It multiplies the profitability of the transaction. E.g. If the transaction achieves a return of 5%, the profit is not $4 (5% of $80) but $800 (5% of $16,000).
In which markets can you use Leverage? Stocks: A stock is a unit of ownership. The owners (called shareholders) are also entitled to receive a share of the company's profits in the case of dividends.
Indices: A stock market index is a statistical record, usually composed of one digit, which attempts to reflect changes in value or average returns of its component stocks. As indices are not physical assets, they can only be invested in through products that reflect their price movements.
Forex: Also known as foreign exchange trading, is a decentralised global market for all currencies traded worldwide. It is the largest and most liquid market on the planet, with a daily trading volume in excess of $5 trillion.
Cryptocurrencies: Are virtual currencies that can be in the same way as currencies but are independent of banks and governments. Leverage products allow investors to gain exposure to major cryptocurrencies, such as Bitcoin, without committing a large amount of capital.
As you can see, in the right hands, leverage can generate returns, but in the wrong hands it can cause serious problems.
In either case, the key is to constantly study and research best practices instead of trying to take advantage without knowledge.
Over time, you can begin to test this tool by using other financial instruments to develop your own strategies.
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