Trading in shares, like any other assets, can be scaled through the use of additional financial tools. When an investor makes an agreement with a stocks broker online, he is usually offered to use leverage to increase profits. At the same time, the investor himself chooses the value of this leverage not higher than the available ceiling set by the broker. What is this tool, and how should it be used?
Leverage Is the Magnifying Glass of Your Trades
Leverage is the borrowed funds that a trader takes from a broker to complete a deal. They allow even relatively small investments to multiply the amount of profit. For example, with a deposit of $10 and a trading leverage of 1:10, you can trade with an amount of $100.
The principle of leverage is valid when trading various assets:
- fiat currencies and cryptocurrencies
- gold and oil, etc.
But each of the assets has its own specifics when using this tool:
- in financial markets leverage can be very high: 1:100, 1:200 and more. You can even find brokers who are willing to give you 1:1000 leverage. Looks very attractive, but only if you don’t realize the risks of using such a high amount of borrowed funds.
- when investors trade shares in the stock markets, leverage is usually less. It allows you to increase the lot traded. That is, when concluding a deal with a leverage of 1:10, 9/10 shares are the borrowed funds of the broker, and 1/10 are your personal funds
What Risks Does a Trader Bear When Trading with Leverage?
When choosing your trading strategy and deciding which leverage to prefer, you need to understand how profit is distributed in the event of a profitable trade and loss in the event of a disadvantageous one:
- profit from trading with leverage is completely taken by the trader, and the broker is only returned his borrowed funds
- in case of a loss, the broker returns his funds in full by debiting them from your account. For example, you placed a lot with a leverage of 1:10 and suffered an insignificant loss, which can be covered by the part of the lot that was backed by your funds. They go to the broker because you pledged them to him to complete the deal. But you must remember that a margin call applies to your entire account. Therefore, in case of serious losses, the broker will not only take your deposit, but also write off the money from the account.
The presence of risks when trading with leverage does not mean that this possibility should be avoided. You just shouldn’t rely on too high leverage until you’ve learned how to work with a smaller one. Try to run your trading operations with a modest amount of borrowed funds. When you see how often you make a profit and how often you lose, you will understand whether it is worth the risk and exactly how much of your own funds you are willing to risk. And then the leverage will turn into real help for you, which, like a magic wand, will increase your profit.
Raj Kumar is a qualified business/finance writer expert in investment, debt, credit cards, Passive income, financial updates. He advises in his blog finance clap.