Introduction to Trading: Leverage
Financial market trading is exhilarating yet risky and complicated. Traders use leverage to boost their potential. This article discusses leverage, how it works, and its merits and downsides for trading newbies.
What’s leverage?
Leverage is using borrowed money to boost investment returns. It lets traders control a greater market position with less cash. Essentially, leverage lets traders increase their gains or losses.
Say you have $1,000 in your trading account and a 1:100 leverage ratio from your broker. Leverage lets you trade $100,000 ($1,000 x 100). So, for every dollar of money, you control $100 in the market.
How Does Leverage Work?
Leverage lets traders borrow from their broker to open greater positions than their account balance allows. This borrowed money is margin. The margin is a proportion of the position size and collateral for the loan.
When you initiate a leveraged trade, the broker demands margin. The proportion is usually 1%, 2%, or 5%. If your position drops below the margin amount, you may get a margin call, asking you to deposit additional cash or terminate the account to prevent losses.
Note that leverage may increase profits and losses. Losses might rapidly exceed your original investment if the market goes against you. Therefore, risk management and stop-loss orders are essential to reduce losses.
Pros and Cons of Leverage
Leverage has pros and cons like any trading technique. Explore them below:
Pros:
Leverage increases traders’ control over bigger holdings, improving profits on successful trades.
Market Access: Leverage lets traders join capital-intensive markets.
Leverage lets traders diversify their portfolios by initiating many bets in various assets.
Flexibility and liquidity: Traders may swiftly initiate and cancel leveraged bets.
Cons:
The biggest drawback of leverage is that losses might exceed the original investment.
Margin Calls: If the market goes against you, a margin call may need more money.
Trade with leverage may cause mental tension due to greater positions and account balance volatility.
When employing leverage, traders may overtrade, making hasty and illogical decisions.
Beginners must grasp leverage and its effects before using it. Leverage trading requires risk management, knowledge, and expertise.
References and sources:
This article used these sources:
Accessed at https://www.investopedia.com/terms/l/leverage.asp
To learn more about leverage in forex trading, visit FXCM: https://www.fxcm.com/markets/insights/what-is-leverage-in-forex-trading/ IG: https://www.ig.com/za/trading-strategies/the-pros-and-cons-of
Always investigate and consult financial professionals before trading.