Leveraging in trading is a powerful strategy that traders and investors use to increase their returns. When used correctly, it can dramatically increase your returns. However, when used incorrectly or with little knowledge, it can have a negative impact not only on your returns, but leveraging can also have a negative effect on your psychology as well.
What is Leverage in Trading?
Leveraging is where you use smaller amounts of initial funds or capital to gain exposure to larger trade positions. Leverage in trading is a very high-risk strategy that needs to be applied with the right knowledge and experience to handle the peaks and troughs of this form of trading.
Keep reading to discover more information on what leveraging is and how you can use it effectively.
Understanding Leverage In Trading In Simple Terms
Leverage: Borrowed money used to control a bigger trade.
Margin: Your own money. Think of it like a deposit. This is the part that you risk.
Leverage in trading means that you are borrowing money from a broker so you can trade with a higher amount of money than you actually have. For example, if you have £100 of your own money (margin) and a broker offers you a leverage of 10:1, this would mean you can control £1,000 worth of trades as you are borrowing £900 from the broker.
In short, leveraging allows you to open a position worth £1,000 with just £100 of your own funds. If the trade goes well, you will make more money, if the trade goes badly, you may lose your entire investment, depending on the margin you used and the leverage that was offered to you.
Below is a table that explains how leverage and margin relate to one another for potential gains vs risk.
| Leverage Ratio | Margin Required | If You Have $100, You Can Control… | Effect |
| 1:1 | 100% | £100 | No leverage. You use all your own money. Lowest risk. |
| 2:1 | 50% | £200 | You borrow £100, resulting in small leverage and small extra risk. |
| 5:1 | 20% | £500 | You borrow £400. Bigger potential profit or loss. |
| 10:1 | 10% | £1,000 | You borrow £900. Your profit or losses are increased by ×10. With a 10% price decrease in the investment, you would lose your entire margin. |
| 50:1 | 2% | £5,000 | Very high leverage with very high risk. |
| 100:1 | 1% | £10,000 | Tiny margin needed (£100), but even small price moves can wipe out your £100, so you will be at a loss. Highest risk. |
Using leverage when trading multiplies both profits and losses depending on which way the market moves. At a 10:1 leverage, even a 10% drop in the market would wipe out your entire £100 margin. At 20:1 leverage, a 5% drop could liquidate your position. For this reason, a margin call might be put into place by the broker to protect themselves and you. A margin call is a warning that tells you to add more funds if you start to make a loss. If you don’t add more funds, your position may be closed automatically to stop further losses.
The Pros Of Leveraged Trading
Leveraged trading has many benefits that are the reason many professional traders use the strategy today.
Access To Bigger Trades
Because you will have access to additional funds from the broker you choose, you’ll be able to trade higher-priced assets that otherwise would be out of your reach.
Potential For Higher Returns
As you will control a large portion of the trade but with less of your own money, the percentage returns can multiply. Small price moves can equal big gains. For example, with a 10:1 leverage, a 1% move in your favour will equal 10% profit on your account.
Efficient Use Of Your Capital
Because you will maintain a smaller cash balance in your trading account, but still have access to larger positions, this will free up your funds for other opportunities. In short, you don’t need to lock up your funds all into one trade; you can diversify across multiple positions. This is known as Capital Efficiency.
The Cons of Leveraging in Trading
Unfortunately, leveraged trading can be dangerous if not used correctly or undertaken with little knowledge.
Amplified losses
Just like small market movements can amplify your profits, they can also multiply your losses. In some cases, depending on the leverage you chose, it can wipe out your entire account balance.
Margin Call And Forced Liquidation
When using leveraging in trading, you are required to have a certain amount of initial margin, also known as equity, to cover any potential losses. If the market moves against you and you find yourself below the required margin (set by you and/or the broker), a margin call may be issued, asking you to add more funds. If you cannot or do not add funds, the broker may close your trade automatically and liquidate your position, causing further losses.
A High Stress Strategy
When using leverage trading, it can be easy to make impulsive decisions out of fear, greed, or panic when watching the profits and losses swing rapidly. Emotional discipline needs to be strong, but it can also become harder the higher you leverage.
Interest Charges
You will gain interest charges as you are borrowing money from your broker. These charges will accumulate over time, especially if the position is left open for a longer period of time.
Easy To Overtrade
When opening large positions using a little amount of personal money, it can be easy to fall into the temptation of trading too big or too often. Although this can sometimes pay off, it opens you up to increased fees, spreads, and a higher risk exposure.
Safe Leverage Practices For Beginners
Leverage in trading can be a useful tool to use; however, it can also be equally risky, especially for beginners. If you aren’t comfortable with leveraging or don’t think you have enough experience, it might be best to stay clear until you do. However, if you want to give it a try, we suggest you follow the tips below.
Start With A Low Leverage
Although you might be tempted to use a larger leverage, such as a 10:1, it’s important to start small. Even most professional traders rarely risk a 10:1 on average trades. You should try beginning with a leverage of between 1:1 and 5:1. This is small enough that if you make a loss, it will not wipe out your entire account.
Use Stop-Loss Orders
A stop-loss is something that is set in place to automatically close your trade if the market moves against you and beyond a limit which you will set. This will prevent you from catapulting from a small loss to a big one. Many brokers offer a stop-loss, as they wish to protect themselves, too, so be sure to use one.
Only Risk A Small Part Of Your Account
To trade safely, you should only risk 1 to 2% of your total account per trade. For example, if you have a maximum of £1,000, your maximum risk should be £10 to £20. This way, you can survive a series of losing trades rather than losing all your money in one lump sum.
Manage Your Margin Wisely
Make sure you understand margins and know how much margin each trade uses. You should always keep some free margin (unused funds you have not invested) for any price swings. This will help if you come up against a loss from price fluctuation, as you will be able to use your free margin to cover the loss. This stops the broker from calling a margin call and closing the trade for you.
Use Demo Accounts For Practice
Most brokers offer demo accounts where you can use virtual funds and test the leverage strategy. This gives you a chance to practice while not running the risk of losing money. It’s a great way to build your confidence in the trade industry and learn the techniques of different strategies, including leveraging.
Know Your Broker’s Policies
Each broker will have different margin requirements, liquidation rules, and overnight fees. Before you come to any agreement and begin trading with leveraged terms, make sure you read and understand your broker’s terms. Aim to choose a regulated broker who has transparent and easy-to-understand terms.
Leveraged trading is a tool to use, not a shortcut or a get-rich-quick scheme. It is useful with the right knowledge, but it can be dangerous if misused.
Trade Safe With STARTrading
Equipping yourself with the right trading knowledge and tools is the best way to confidently trade in all market conditions, whether using leverage or not. Our team at STARTrading are industry experts in providing training and trading courses for beginners. With us, you can learn in a realistic but short time frame and soon work less, stress less, and have more fun through trading. We are all about financial peace, and want to pass our knowledge on so that others can reach financial freedom too!
Take a look at our upcoming swing trading courses, our mini-series, our trading ebook , or contact us today with any questions. Our team will be happy to help and assist.
