The use of leverage is highly attractive to traders as it provides them with exposure to trading positions that can be multiple times bigger than their capitals. In this article, you will learn how leverage trading works and whether it’s beneficial for your trading portfolio.
Leverage trading allows traders with relatively small amounts of capital to gain limited exposure to larger trading positions. The key to that is the use of borrowed funds. Leverage multiplies potential gains as well as losses. That’s why strategy, risk management, and the understanding of margin are incredibly important.
In leverage trading, a margin is a minimal amount required for opening a certain position. For instance, if your leverage is 10:1, the margin you have to pay to enter a position is 10%. Now you can easily calculate that a $10,000 position has a margin of $1,000 if the leverage is 10:1.
The market offers several leveraged products that are derivatives with the actual market value higher than investors’ initial deposits. The most popular leveraged products are CFDs (contracts for difference) and spread betting opportunities. The first type is more popular, though, as it’s exempt from the capital gains tax, which means higher potential profits.
Both products allow traders to enter small-margin positions without the need to purchase any actual underlying assets. The potential profits and losses, however, depend on the market and the performance of these assets.
Other leveraged products include:
All types of trading involve risks, but the risk rates of all products are different. In the case of leverage trading, the initial risk rates of leveraged products are multiplied accordingly to the size of potential leveraged profits. That’s why leveraged trading is allowed only if you have a detailed strategy that covers all possible worst-case scenarios without leaving you with nothing but huge debts. You have to figure out the acceptable amounts of risk per single trade as well as per trading day. Always determine the specific amount you can afford to lose without falling out of the game and don’t let yourself go over this potential amount even if the potential profits are promised to be cosmic. Don’t forget that the losses can always be equally “terrific.”
No matter how large the risks are, a proper risk-management strategy will help you gain enough control and protect your assets from disappearing.
The most commonly used tool on this market is stop-loss. Using a stop-loss order on your trading platform, you can limit the losses in advance by setting up the lowest unfavorable limit. You can’t use it to eliminate losses completely, but your account won’t be emptied in case of a severely negative trend. Stop-loss orders usually charge a small fee but prevent you from losing too much, so it’s not recommended to avoid using them even when you become an experienced trader.
Entering leverage trading, you can either start by testing your strategies on a demo account or go with a real-money account right away. Both options have their pros and cons, though:
The opportunities of leverage trading may look very realistic even if the actual success rate is very low. That’s why you should always approach this trading technique with a well-developed strategy and thoroughly managed risks. Use your knowledge and don’t let emotions rule the trade.
