You finally decide to follow your newfound interest in trading and have just started your journey. You’re excited to learn everything about this matter, from different types of financial markets you can invest in to tools that can help you enhance your profitability. Some of the terms that every novice trader will come to face at some point are leverage and leverage trading.
For a successful trading journey, it’s extremely important first to wrap your head around these concepts fully. You might’ve heard industry cliches such as ‘leverage: a double-edged’ sword and such. These cliches stem from the truth. What truth, you ask? The truth about leverage trading, which you’ll be learning by heart at the end of this article.
So buckle up and join our team at ITBFX on a long, exciting journey to learn everything about leverage trading!
What Is Leverage Trading?
Leverage trading refers to the act of borrowing money from the broker to increase one’s profitability. When you use leverage in trading, you’re essentially borrowing funds from your broker to increase your market exposure, which is the amount of money you invest in a single asset or trade.
Increasing your market exposure means you can control larger trades, and the larger your trade size is, the more money you can make from it.
Of course, the growth in your trade size also means your potential losses are heightened. So that’s where the cliché comes from.
Leverage trading isn’t always the bearer of good news. As much as it can elevate your profits, it can also magnify your losses, hence the double-edged sword analogy.
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How Does Leverage Trading Work?
Now that you have a rough idea of what leverage trading is, it’s time to take a more in-depth look into how you can profit from it. As we established, leverage trading involves borrowing funds in hopes of increasing your potential profits. Leverage is expressed as a ratio, for example, 10:1. This means that for every dollar of your own capital, you can trade $10.
Using leverage in trading can magnify both your risks and rewards. For example, suppose you have $1,000 you want to invest in the forex market. Without leverage, if the market moves 1% in your favor, your profit would be $10. On the other hand, if the market moves against your position by 1%, you’ll lose $10.
Now, consider you’re using a 100:1 leverage. With that in mind, if you have the same capital of $1,000, the leverage enables you to control one standard lot ($100,000). Now, if the market moves 1% in your favor, you’ll earn $1,000.
The same goes for your losses. Considering a 1% market movement against your wishes, you’ll be losing $1,000. This example shows the importance of carefully considering your risk-reward ratio when trading with leverage.
Trade Size, Margin, and Leverage Trading
When speaking of leverage, you usually bump into the word margin somewhere along the way. Margin refers to the amount of money your broker requires you to have in your trading account at all times when trading with leverage. Essentially, the margin acts as a collateral that ensures you don’t lose more than what you can afford.
If your account balance falls beneath the margin requirement level established by your broker, you will face a margin call. In this case, you will need to either deposit more funds into your account or close some (or all) of your positions. Otherwise, the broker will close your position for you, which is called liquidation.
While leverage is expressed as a ratio, the margin is a percentage of the notional value of the trade. If you inverse the leverage ratio and multiply it by 100, you’ll be left with a margin. So, suppose you have a 20:1 leverage. This means that for every dollar of your actual capital, you can manage 20 dollars.
Now, following the formula from above, if you inverse this leverage ratio and multiply it by 100, you’ll have your margin requirement.
The margin requirement shows what percentage of your leveraged trade you need in your account. If you’re trading a standard lot, for example, you will need 5% of your trade ($5,000) in your account at all times to be able to continue using your 20:1 leverage. You can also determine your trade size by multiplying your capital by your leverage.
Leverage Trading in Forex
The foreign exchange market (forex or FX) is the largest financial market in the world, with a daily trading volume of $7 trillion. With different types of currency pairs, from super liquid major pairs to extremely volatile exotics, the forex market is considered a land of opportunities. Many traders hope to multiply their potential gains in this market by participating in leverage trading.
Standard forex leverages are between 30:1 and 100:1, meaning you can manage trades 30 to 100 times larger than your actual capital would allow. Keeping this in mind, it’s good to know that brokers usually offer much higher leverage ratios, which might sound enticing.
However, you should consider your risk tolerance before choosing a leverage so your account doesn’t get wiped out. Usually, traders, and especially novice traders, are encouraged not to choose the highest leverage offered by their broker.
Leverage Trading in Crypto
With recent developments in the blockchain and web3 industries, cryptocurrency trading has become more popular than ever. This market provides extensive opportunities to make money. However, its extreme volatility can quickly turn it into a rabbit hole many traders get sucked into.
Due to the massive risk associated with the cryptocurrency market, it’s recommended that investors steer clear of extreme leverages. As a result, leverage trading in crypto usually contains lower ratios such as 5:1, 10:1, and 20:1. This way, you can increase your potential gains while making sure you won’t lose all your capital due to market fluctuations.
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Leverage Trading in Stocks
The stock market provides an opportunity for the average person to invest in the share prices of certain companies. With big industry players such as the New York Stock Exchange (NYSE) performing better and better every day, more investors are drawn to this market.
You might want to choose stock market investments for several reasons. First and foremost, you might want to use your shareholder’s rights to have a say in how the company is run. Moreover, you can have a stable income from the dividends of the shares you own. Last but not least, you can trade these stocks to profit from the short and long-term fluctuations in their prices.
If you fall under the third category, there’s a good chance you will also be bewitched by the many advantages of leverage trading. However, as with any other financial market, it’s important not to risk more than what you can afford to lose.
Leverage Trading in Indices
In the world of financial markets, indices are financial instruments designed to show and gauge the overall performance of a specific asset class. These financial instruments include a set of securities or other assets, such as currency pairs.
Some of the most well-known indices around the world include the S&P 500, Dow Jones Industrial Average (DJIA), FTSE 100, and CAC 40.
The average leverage ratio for index trading usually revolves around 20:1. However, many brokers offer much higher leverage. If you’re interested in using these higher ratios, you should first establish a robust risk management strategy.
Leverage Trading in CFDs
Last but not least, it’s a good idea to also review leverage trading in the CFDs market. CFDs, or contracts for differences, are financial derivatives from several markets, including forex, stocks, and commodities.
Because they’re derivatives, you will not hold any sort of possession over the actual trading instruments (currency pairs, stocks, commodities) while trading CFDs. Rather, you’ll be betting on the possible price movements of these instruments in the future.
CFD trades are pricey to keep open. With wide spreads and high rollover rates, CFD contracts are usually opened and closed over the span of a few days. As a result, there are not as many ‘buy-and-hold’ opportunities in this market, which makes it more risky.
This risky nature, in addition to the uncertainties of leverage trading, makes traders extremely cautious while trading CFDs with leverage. As a result, new traders are always advised to stay away from high leverage ratios if trading CFDs.
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Pros of Using Leverage in Trading
Leverage trading has always been an attractive concept to both novice and professional traders. With the correct risk management strategies, leverage trading can offer significant benefits to traders. In this section, you’ll learn about these benefits.
- Increased Market Exposure: Most of the benefits of leverage trading fall under its definition. As you learned earlier in this article, using leverage in trading will allow you to borrow funds from your broker and increase your market exposure or the amount of money you can control in your trade(s).
- Significant Growth on Potential Returns: With a larger trade size, stakes are higher, and so are your potential returns. By accumulating funds and trading a larger position, you might turn your hundred-dollar profit to $1,000.
- Outsourcing and Capital Efficiency: Since leverage trading helps you finance larger trades from an external source, you can spend smaller chunks of your actual money on different trades and gain profits. This way, you can open more positions and diversify your portfolio, which is not only a good risk management technique but also a great way to use your capital more efficiently. Of course, you need to keep in mind that, like all other kinds of trading, there’s no guarantee of profits in leverage trading as well, and there are always risks to consider.
Cons of Using Leverage in Trading
Leverage trading also involves risks and drawbacks you need to learn about. Here are the most important cons of leverage trading:
- Excessive Risk: Think of leverage in trading as a multiplier. Just like it can magnify your returns, it can also easily amplify your losses, leading to fast, excessive capital loss. Even if you would’ve lost $10 on an unleveraged trade, you might overleverage and turn this $10 into thousands. As a result, it’s important to fully develop and test a risk management strategy before you indulge in leverage trading.
- Possibility of Margin Call and Liquidation: As mentioned above, when your account balance reaches below the margin requirement level in your broker, the broker will send you a margin call, an alert that leaves you with two options. You could either inject more money into your account or close your trades. Depending on how much below the margin requirement you are, you can determine how much money you need to deposit into your account or how many trades you need to close. To do so, use a margin or leverage trading calculator. But remember, if you fail to take action in a timely manner, your broker will liquidate your trades on your behalf, leading to significant losses.
- High Fees and Interest Rates: Leverage trading involves borrowing money from your broker, which has its own costs. You should be aware of the costs and interest rates associated with the leverage you use. It’s also important to choose a broker that offers competitive fees and rates so you can spend your money on actual trades and not on bureaucratic fees.
Leverage Trading Risk Management Techniques
Hopefully, we’ve been able to stress the importance of risk management in leverage trading adequately. But how can you design a risk management strategy and make sure you’re doing everything in your power to protect your capital?
Learn First, Trade Later
The first thing you need to do is study! Although the concept of financial markets is incredibly vast, and no one can literally know everything there is about it, you need to take the time and educate yourself on different financial markets (especially the one you’re going to trade in). You should find the answer to questions such as “What is leverage trading?” or “How does leverage trading work?” before you start trading, as there are basic yet important concepts to cover.
There are a ton of useful sources to educate yourself about trading. For one, you can head over to ITBFX and use our various educational content, including blogs, videos, and our ITB Academy, which will help you kickstart your journey as a trader.
Choose the Right Broker
No matter if you’re trading crypto, forex, or other markets, it’s vital to choose the best broker for leverage trading. Choosing the right broker includes the considerations of many factors, including trading instruments, leverage ratios, spreads and commissions, trading platforms, and account types.
Here at ITBFX, we offer more than 1,000 trading instruments, which you can trade on MetaTrader 5 and our exclusive trading platform, ITB Trader. Our accounts include nano, standard, and ECN accounts. You also have access to our demo account, which we will discuss in a little bit. Most of our accounts have commissions, and our spreads begin at 0.0 pips. The maximum leverage available at ITB Broker is 500:1, which allows for exploiting the market without crazy risks. You can also join our IB plan to start earning passive income.
Don’t Jump Into the Live Market Yet; Use a Demo Account Instead
Although it might be very tempting just to start trading and making money, you need to practice first. Find a good broker and open a demo account on it. These account types will give you the closest experience to real-world trading, only without real money.
By opening a demo account, you can test your trading plan and strategies, as well as familiarize yourself with the broker you’ve chosen. Even if you’re not new to trading, it’s best you hold a demo account open to test new techniques and strategies.
Our demo accounts on ITB Broker offer you $1,000 of virtual funds to trade with, and there’s no limit on how many demo accounts you can have.
Stick to Your Trading Plan and Steer Clear of Emotions
Perhaps one of the most damning factors that doom many traders is not following their trading plan and deciding with emotions running high. First, define a robust trading plan, test it through demo accounts, and then make sure you stick to it and trade with discipline. No matter if your trades perform great or awful, beware of fear and greed. Of course, if all your trades are failing miserably, you need to reconsider your trading plan. However, if only one trade performs exceptionally well or poorly, don’t let it cloud your judgment for upcoming investments.
Use Your Tools Wisely
When choosing a broker, keep its trading tools in mind. Use your stop-loss orders to limit the amount of money you lose. You can also use trailing stop-losses or guaranteed ones to further protect your capital. Limit orders are also a great option to consider. They help you close your position at a certain price point to secure your gains.
Don’t be shy; use technical or fundamental analysis (or both) to determine entry and exit points. Let indicators, patterns, and economic calendars help you.
By taking these tips into consideration, you can set good grounds for your trading journey. Of course, education is always key, and you should keep up with the market to continue improving yourself.
Conclusion
If you’re interested in financial markets and trading, you might have wondered, “What is leverage trading?” or “What is leverage in trading?” In this article, we learned that leverage trading is the process of borrowing money from your broker to increase your market exposure and enhance your potential returns.
To use leverage in your trades, you should have a certain amount of capital in your trading account, which is called the margin. Using leverage and margin could be extremely beneficial in markets such as forex, crypto, etc., but it can come with excessive risks as well. Traders who choose to take part in leverage trading should have a great risk management strategy and steer clear of overleveraging.
To learn more about trading and different financial markets, you can visit our ITB blog. Otherwise, don’t hesitate to leave us your comments down below!
What is leverage trading?
Leverage trading is borrowing money from your broker to increase the size of your trades and, ultimately, your market exposure. Traders use leverage to amplify their potential returns. While leverage trading could be very beneficial, there are great risks that accompany it that you need to be aware of.
What is leverage in trading?
Leverage is the money you borrow from your broker to increase your market exposure and potential gains. It is expressed as a ratio and acts as a multiplier, for example, 30:1. If you use a 30:1 leverage, you can control $30 with every dollar of your actual capital.
How does leverage trading work?
When you use leverage, you borrow money to increase your funds and position size. The larger your position size is, the more your profits or losses will grow. If you use a 100:1 leverage ratio, your potential gains or losses will grow tenfold.
What’s the best broker for leverage trading?
You should avoid brokers that offer extremely high leverage ratios, such as 3000:1 or 2000:1. Instead, choose a broker that gives you the opportunity to partake in leverage trading while trying to protect your funds. With a maximum leverage of 500:1, ITBFX aims to help you have a profitable, sustainable trading journey.
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