- Leverage trading can give your trades enormous upside if you do it correctly
- It also carries certain risks that you need to pay attention to
Leveraged trading is one of most powerful tools retail investors can use to maximize their earning potential. At the same time, leverage in trading could be a quick way to wipe your account clean if you act carelessly in the market. With this in mind, let’s dive in and explore opportunities and risks surrounding leveraged trading.
What Is Leveraged Trading?
So, what exactly is leveraged trading and how does leverage trading work? For its part, trading in the financial markets can take many forms. Additionally, the ever-growing investment world has gotten so big the small investor might not stand a chance at reaping substantial returns.
For example, imagine you have $1,000 to invest. And you’d like to buy shares of Tesla (TSLA) worth above $1,000 each. If you used your own money, it wouldn’t even be enough to get you one share of the EV maker. That’s when leveraged trading steps in.
In practice, leveraged trading is your ability to open positions much bigger than your initial capital. This said, a third party, ie your broker, will allow you to borrow the funds so you can have greater upside when the moves play out in your favor.
Generally, all online trading brokers offers their clients the option to choose how much leverage they want to use. Some could offer 50:1, while others may reach 500:1. Let’s talk more about this.
An Example Of Leveraged Trading
Here’s an example: let’s decide to use leverage of 100:1. Now our $1,000 have the buying power of 100 times more, or $100,000. In other words, we only need to show up with 1% of the total transaction value. That sounds like it will make a difference, right? Certainly, because technically, you are able to buy 100 shares of TSLA stock if it’s trading at $1,000 a share.
If we break down the numbers, a leverage of 100:1 means you can open a position of $1,000 (or 1 TSLA share) with just $10. Even more so, if we raise the leverage to 500:1, you buy $1,000 worth of TSLA for just $2.
This way, you can control market positions with value way larger than your actual investment. To this end, leveraged trading is so common it is used by virtually every retail trader.
Before you jump in the market with 500 times your money, let’s pause for a second. Let’s get a deeper look at what you can do and what you should never do when trading with leverage.
Pros of Leveraged Trading
The biggest benefit leveraged trading gives you is the ability to get more bang for your buck. By borrowing money from your broker, you are maximizing your chances for greater returns. Essentially, without leverage, your trading would be limited only to the money you put on the table.
Now that you use leverage, you magnify your profits. Let’s illustrate this so we can see how it really works for you.
How To Use Leverage In Forex
Let’s say you’re eyeing the EUR/USD pair at a price of 1.1450 and you believe the euro will rise in value. You have 1,000 EUR in your account and your broker gives you a leverage of 100:1. What you need to do now is decide how much from your funds you want to put in the trade.
Let’s go for a purchase of 10,000 units, or a long position of 10,000 EUR. In other words, you sell dollars to get euros. Now you have an open position of 10,000 EUR with just 100 EUR invested from your account (leverage used is 100:1). You pip value, or profit per pip, is 0.87 EUR, or 87 EUR for every 100-pip move.
A move up by 87 EUR would mean you get 87% return on your investment (ROI) of 100 EUR. Still, experts say it’s better to focus on return on equity, and not so much on return on a single investment. In the case where your account holds 1000 EUR, this return would grow your funds (or equity) by 8.7%.
Cons Of Leveraged Trading
It’s true that financial leverage, used properly, could shoot your returns to the moon. Significant profits, however, may not materialize and the trade could turn against you. Essentially, this is an outcome you need to be prepared for.
Just as it could magnify your profits, leveraged trading could magnify your losses. Therefore, you must have a strict trading strategy in case your trade turns sour. If we take the above example and turn it the other way, your account would be looking at an 8.7% drawdown.
How, then, do you protect your account from magnified losses? Use trading setups. In other words, design your approach to market by introducing trading rules. These could include setting a stop loss order and a take profit order.
What’s a stop-loss? It serves as protection to your account if the trade turns against you. A stop-loss will make sure your trade is closed automatically when the price reaches your stop-loss level. On the other hand, a take profit order will close your position at a pre-determined profit level.
Leveraged Trading vs Spot Trading
What’s the difference between leveraged trading and spot trading? The main distinction between these trading styles is, essentially, the leverage. Spot trading will allow you to trade in financial markets “on the spot”, with no leverage.
In contrast, leveraged trading enables you to bet more than your own money as you borrow from your broker and then return the borrowed amount. Don’t worry, this happens automatically and there are no hidden fees that can chip away at your funds.
Leverage Trading Strategies
The benefits of leveraged trading are quite literally enormous. First of all, you need to decide for yourself how much leverage you need. Another term to describe it could be margin requirement. You are likely to be asked this by your broker.
In more detail, you can choose a margin of 1%, which would be equal to a leverage of 100:1. To this end, you can design a trading strategy that will give you control. As we mentioned above, you can use stop-loss orders and take-profit orders.
In conclusion, make sure you find a reputable and honest broker that will give you the ultimate leverage trading experience. Our own TradeOr platform is designed to give you just that. Head over to our account opening section to read more about our services, markets on offer, and all features packed neatly in our trading platform.
- What is leveraged trading?
Leveraged trading is your ability to open positions much bigger than your initial capital. This said, a third party, ie your broker, will allow you to borrow the funds so you can have greater upside when the moves play out in your favor.
- Is leveraged trading profitable?
Yes. The biggest benefit leveraged trading gives you is the ability to get more bang for your buck. By borrowing money from your broker, you are maximizing your chances for greater returns. Essentially, without leverage, your trading would be limited only to the money you put on the table. When you use leverage, you magnify your profits. It can also magnify your losses if the trade turns against you.
- How to start leveraged trading?
The way to start leveraged trading is to go to an online broker that offers trading on leverage. Once you find it, check the different options. Some will allow leverage of 50:1, while others will scale up to 500:1. Decide for yourself the level of risk before choosing your broker.