Leverage is a powerful tool for investors as it can help them maximize returns, grow their capital exponentially and increase their exposure to their desired markets. Keep in mind that leverage can work for or against you. You can make large profits or suffer losses when prices move against you. When you trade with leverage, you put in a “small amount”, but you have the opportunity to control a much larger trading position in the market. This small amount is called margin.
In leveraged trading, the trader only needs to invest a certain percentage. The type of market traded can also dictate the amount of leverage traders can use. Volatile markets, such as bitcoin, should be traded with minimal leverage. The leverage ratio is a representation of the value of the position relative to the amount of investment required.
What is margin trading?
Margin is the amount of money a broker allows a trader to put up to trade a much larger position in the market. It is essentially a security deposit held by the broker. When trading positions are held, price changes in the market will also cause changes in margin conditions.
Advantages and Disadvantages of Leverage Trading
Top 5 Advantages of Leverage
1. Leverage increases the capital available for investing in various markets. You can allocate significant amounts to various trading positions in your portfolio.
2. Leverage is a loan provided by your broker to allow you to take a larger position in the market. This loan does not carry any obligations in the form of interest or commissions.
3. Leverage trading allows traders to make larger profits from trades that are favorable to them. Profits are obtained from the controlled trading position and not from the deposited margin.
4. Price changes in the markets usually occur in cycles of high and low volatility. Most traders like to trade in high volatility markets because they make money on price movements. With leveraged trading, traders can make higher profits even during these times of low volatility.
5. Leverage allows traders to trade instruments that are considered more expensive. Some instruments are highly priced and this can leave out retail investors. But with leverage, these markets include the retail investor.
Disadvantages of Leverage
The biggest risk when trading with leverage is that losses are also amplified when the market goes against you. Leverage may require a minimal outlay of capital, but since trading results are based on the total size of the position you control, losses can be substantial.
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