Leverage in Trading

Understand how financial leverage allows you to trade with more capital than you have, amplifying both profit opportunities and risks.

Table of Contents

Definition

is a strategy that allows traders to trade with a larger amount of money than they actually have available in their account. In other words, leverage works as a “temporary loan” that the broker grants to the trader to increase his investment capacity in a market.

How does leverage work in trading?

Leverage is based on a ratio (such as 1:10, 1:50 or 1:100), which determines how many times you can multiply your initial trading capital. For example, with a leverage of 1:50, you can control a $50,000 position with only $1,000 from your account.

  • Size of the position: This is the total value of the transaction.
  • Margin: The amount retained as collateral.
  • Leverage multiplier: It is the key that allows to increase the exposure to the market.

Example

If you have $1,000 of capital and ask for a leverage of 1:10, you can open a trade worth $10,000 in the market. However, your risk also increases proportionally. You multiply the capital and multiply the risk.

Margin

Margin is the amount of money that the broker “holds” from your account to cover the trade you are making with leverage. It is like a margin deposit that ensures that you can assume the possible losses of the position.

  • Initial margin: The minimum capital required to open a leveraged position.  
  • Maintained margin: It is the capital that you must keep in your account while the position is open.  

For example, if you trade with a leverage of 1:10 and open a $10,000 position, you only need $1,000 as initial margin.

Margin Call:  

Margin call occurs when the balance in your account is insufficient to maintain open positions. This happens if accumulated losses reduce the available capital below the required margin.

When it happend

  1. Your broker notifies you that you need to add more funds to your account.
  2. If you fail to do so, the broker may automatically close your positions to prevent you from losing more than you have in your account.

Example 1: Margin calculated with leverage

  • Position size: $10,000  
  • Leverage: 1:20  

Retained Margin= (10,000/ 20) 500

The broker will withhold $500 from your account as collateral.

Example 2: Margin calculated with percentage requirement  

  • Position size: $50,000  
  • Margin requirement: 2% (1:50 leverage equals 2%)  

Margen Retenido=50,000×0.02=1,000

The broker will withhold $1,000 from your account.

Example 3: Trading a Forex pair    

  • You are trading the EUR/USD pair.
  • The standard lot size is 100,000 units (1 lot = 100,000 euros).
  • The current price of EUR/USD is 1.10, so the lot value in dollars is: Lot value=100,000×1.10=110,000 USD.
  • Your broker offers a leverage of 1:100 (1% margin).

Retained Margin=110,000×0.01=1,100 USD.

You must have $1,100 available in your account to open the position.

Keys to avoid margin call:

  • Use stop loss to limit losses.        
  • Trade with leverage you can handle.
  • Monitor your positions regularly.
  • Have an additional capital cushion in your account.

Advantages and Risks

Advantages Risks
Increased market exposure: Trade large positions with a small initial investment.Amplified losses: Losses are multiplied by the same amount as gains.
Profiting from small movements: Make significant profits on small changes in price.Margin Call: If the available balance falls below the required margin, you could lose your position.
Diversification: You can invest in multiple assets without a large capital.Market volatility: Sharp movements can quickly consume your margin.
Access to exclusive markets: Leverage allows trading in markets such as Forex or stock indexes. Forced position closure: If you do not manage risk, the broker could close your trades automatically.

FAQs

1.What leverage is recommended for beginners?

It is best to start with low leverage, such as 1:10 or 1:20, to reduce the risk of significant losses.

2. How to avoid a margin call? Use risk management tools such as stop loss, trade with sufficient margin and monitor your positions regularly.

3. Can I lose more money than I have in my account? In most cases, regulated brokers have negative balance protection, which means that you cannot lose more than what you have deposited.

4. Which markets allow trading with leverage? Leverage is available in markets such as Forex, CFDs (stocks, indices and commodities), cryptocurrencies and more.

5. Does leverage affect commissions and spreads? Not directly, but as the position size is larger, the related costs (commissions and spreads) will be proportionally higher.

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