• 29 Nov 2023

INTRODUCTION

The concept of leverage in the world of finance can essentially be viewed as a powerful tool in the world of trading and investing, which will boost the profit or losses made by a client in a particular trade. Leverage allows traders to take a larger position in the market with a smaller amount of capital.

Leverage is the powerful ability to make gains from a small percentage on shares, forex pairs, commodities, indices and ETFs. Leverage allows traders and investors to control a larger position in an asset than they would with their own capital alone. By doing so, they can amplify the potential gains from a successful trade.

It works by using a deposit known as a margin to provide one with increased exposure to an underlying asset. Used as a financial magnifying glass to understand the potential gains and associated risks, Leverage trading is the secret weapon of many smart traders.

BENEFITS OF LEVERAGE

Not only does leverage provide traders with a flexibility of taking up significant positions in the markets without tying up excessive amounts of capital, but also magnifies the size of any profits that one might make. One can gain the same amount of market exposure by depositing just a small fraction of the total value of their trade. For example, if you have $1,000 and use leverage of 10:1, you can control a position worth $10,000. If the asset's value goes up by 5%, you'd make a $500 profit instead of just $50 (5% of $1,000).

Another key benefit of leverage is that it helps magnify returns, which is great news if the market moves in the direction that is expected. Many people are attracted to trading forex compared to other financial instruments owing to the higher leverage that is received by trading forex, than with stocks. Using leverage can free up capital that can be committed to other investments. In addition to this, trading can be done around the clock.

Forex trading often offers higher leverage compared to other financial instruments. This increased leverage potential in the forex market can be appealing to traders because it allows them to control larger positions with relatively less capital.

The utilisation of leverage can free up capital that traders can allocate to other investments or use for additional trading opportunities. It allows traders to diversify their portfolio and facilitate the reduction of opportunity cost.

RISKS OF LEVERAGE

While leverage is a powerful tool it will also increase your risk. It is important to use leverage judiciously and understand the possible risks involved in trading on margin.

Another risk of leverage is that one’s positions may be at the risk of being closed automatically if they don’t have enough margin in their account to cover any losses. In this situation, they will be placed on a margin call.

Traders must be cautious not to over leverage their positions, as this can lead to substantial losses. Effective risk management is essential to mitigate this risk.

This is where the double-edged sword comes in as real leverage has the potential to enlarge one’s profits and losses by the same magnitude. While assets may rapidly depreciate in value, financial losses may escalate as a result of financial debt.

Also Read:-Common Mistakes To Avoid In Forex Trading

BEST PRACTICES

Traders should choose the level of leverage that they are the most comfortable with. To trade safely, they should set a limit that they are prepared to lose on a trade. This is usually set by many traders at 2%. If they aren’t comfortable with the level of leverage they are utilising on a trade, then they can decrease the same. They can also use the margin sensibly, while utilising stop orders and hedging to prevent losses.

CONCLUSION

Leverage can prove advantageous once one has learned how to manage it. Like any other financial instrument, leverage too must be handled carefully. As it is flexible and customizable to each trader’s needs, leverage can be successfully and profitably used with proper management.


- Savitri Sendhil Kumar

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