Leverage is a powerful and efficient trading tool that is often neglected or even misunderstood by beginners. Most novice traders think leverage is not for them, which is not true. Firstly, leverage is an integral part of CFD trading. Despite being promoted as a double-edged sword, leverage can indeed show you positive outcomes. All you need is to choose the right leverage according to your trading, and leverage will then do its work to help you minimize your losses while elevating your trading.
Understanding Leverage:
The major reason for the failure of traders when it comes to leverage trading is they are unable to understand the impact of leverage on their trading, meaning they are often undercapitalized when they start with leverage trading.
So, what exactly does leverage signify? In simple words, leverage refers to the trader’s ability to invest much more money than he owns in his account, which he usually does by borrowing additional funds from the broker. The main reason for opting for leverage is traders want to get exposure to larger trades. The biggest advantage and risk associated with leverage trading is that it can magnify both potential profits and losses. Thus, you can make profits if the market goes in your direction, but you can even record significant losses if it goes against you.
Financial Products Where Leverage Can Be Used:
You can find numerous financial products in the market for traders where they can apply leverage:
- Forex
- CFD (Contract For Difference)
- Futures
- Options
- ETF (Exchange-Traded Funds)
Benefits Of Using Leverage Trading:
1. More Profits:
Leverage has the potential to amplify market movements, so the traders can gain more profits through leverage trading, although exposure to potential losses is equally magnified.
2. Can Start With Small Capital:
The best thing about leverage trading is that you can start with a small amount of your own capital and borrow the rest from the broker to get more market exposure which otherwise would not have been possible.
“There are a million ways to make money in the markets. The irony is that they are all very difficult to find.” – Jack D. Schwager
3. Diversity The Portfolio:
Another main advantage of leverage trading is you get the opportunity to diversify your investment portfolio as you can trade in numerous markets simultaneously.
4. Take Advantage Of Market Movements:
Leverage trading, particularly in the case of derivatives such as CFDs, helps you take advantage of the rise and fall of the markets.
5. Trade Non-Stop:
Depending on the type of market you choose to trade in, the traders can potentially trade non-stop even after the trading hours are over.
Risks Of Using Leverage Trading:
1. Double-Edged Sword:
Since leverage is considered to be a double-edged sword, it has the potential to magnify both your profits and losses, meaning the risk of losing all your money is also enhanced.
2. You Don’t Own The Asset:
When using leverage in CFD trading, the traders don’t own the underlying asset, which is a significant disadvantage.
3. Additional Fees:
You need to pay some funding fees when you borrow funds with leverage trading. For Example: if you tend to keep your trades overnight, you are required to pay overnight fees.
4. May Lead To Unbearable Losses:
If you predict the wrong direction for a particular trade, you will be in a losing position that makes your capital fall even below the minimum requirement for keeping your position open. Thus, your broker will issue a margin call in such a case and would ask you to fund your account (which you need to do so from your own pocket) if you want to keep the position open.
Examples:
How much money can a trader invest with $1,000 through leverage?
- Leverage Ratio 1:1 = $1,000
- Leverage Ratio 10:1 = $10,000
- Leverage of 20:1 = $20,000 and so on.
Tips To Pick the Ideal Leverage Level For Your Trades
Before you start using leverage for your trading, you must understand how leverage can assist you in your trades. Additionally, you must also consider your trading experience and knowledge, financial objectives, initial trading capital, and trading styles, such as scalping, swing trading, and day trading, because leverage is not suitable for all trading types and styles.
- The first tip is quite simple; every trader must understand the true meaning of leverage, how it works and how it can help them. Most beginners use leverage without knowing about them, which should not be the case.
- Leverage is a popular trading tool; however, traders should not take it lightly because of its potential to wipe out all your money if not used properly.
- The next tip involves choosing a regulated broker that lets you change leverage whenever required.
- Another tip is to change your leverage according to the current market conditions.
- For a beginner, the lowest leverage should always be preferred.
- Traders should always use the stop-loss strategy to protect their trading capital and reduce potential risks.
- Traders should never allocate more than 2% of their capital for one trade.
- Additionally, the traders must utilize certain tools to understand the leverage impact on their trades.
- Always start with a demo account where the traders can trade through virtual funds to find the best leverage for their trading.
Conclusion:
You may now understand what leverage is and how to optimize its use for your trading to maximize your profits and minimize the risks.