What is Leverage?
Leverage is often used in the financial world, but what does it mean? Put; leverage is borrowing money to trade. It amplifies your profits (or losses) based on the size of the position that you take(view page).
For example, if you have a $1,000 account and use a 10:1 leverage ratio, you can trade a position that is worth $10,000. It magnifies your profits (or losses) by ten times the amount that you have in your account.
Leverage ratios vary from broker to broker, so it’s essential to do your research before selecting one. Most brokers offer leverage ratios of 2:1 or 3:1, but some go as high as 500:1.
What are CFDs?
CFDs (or contracts for difference) are a type of product that allows traders to trade on the price movements of an underlying asset without having to own the asset itself.
For example, you could use a CFD to bet on whether the price of gold will go up or down. If the price goes up, you will buy a “long” CFD. If you think the price will decrease, you will sell a “short” CFD.
CFDs are popular because they allow traders to take positions on various assets, including stocks, currencies, commodities, and indices. They are also one of the most leveraged products available, with leverage ratios of up to 500:1
Leverage is a critical factor that separates CFD trading from traditional stock trading. With CFDs, you can trade a much more prominent position than you could with traditional stocks, which means your profits (or losses) are also magnified. For example, if you have a $1,000 account and use a 10:1 leverage ratio, you can trade a position that is worth $10,000. It magnifies your profits (or losses) by ten times the amount that you have in your account.
Why Use Leverage?
There are two main reasons traders use leverage: to increase their profits and reduce their risk.
When used correctly, leverage can be a powerful tool to help traders make more money. However, it’s important to remember that using leverage increases your risk. A slight loss can wipe out your entire account if you’re using high leverage.
How Does Leverage Work?
Leverage works by increasing the amount of money that is available to trade. It increases the size of your position, and, as a result, the profits (or losses) that are generated are also amplified.
For example, if you trade a position worth $10,000 with a 10:1 leverage ratio, you will need to deposit $1,000 into your account. However, if the position moves in your favour by 10%, your account would be credited with $1,000 (the original $1,000 plus 10% of $10,000). If the position moves against you by 10%, your account would be debited by $1,000 (the original $1,000 minus 10% of $10,000)
It’s important to note that leverage doesn’t always result in a positive or negative outcome. If the position moves by 5% in either direction, you would neither profit nor lose money.
How Much Can I Lose?
One of the biggest dangers of using leverage is that it can lead to significant losses if the trade goes against you. For example, if you have a $1,000 account and use a 50:1 leverage ratio, you could lose up to $50,000 if the trade goes wrong.
It’s important to remember that losses can also exceed your original deposit, so it’s important to only trade with money you can afford to lose.
Is Leverage Safe?
Leverage is a double-edged sword, and it’s essential to understand the risks before using it. A slight loss can wipe out your entire account if you’re using high leverage. However, if used correctly, leverage can be a powerful tool to help you make more money.
It’s important to remember that leveraged products such as CFDs are complex and come with a high risk of losing money rapidly due to excessive leverage. Before deciding to trade leveraged products, you should consider your investment objectives, experience level, and risk appetite.