The Ultimate Guide to Leverage Trading
What is Leverage Trading?
Leverage trading is a type of trading where you use borrowed money—known as “leverage”—to increase your potential returns. When you trade with leverage, you can control a larger position than you could with your own capital alone, magnifying both your profits and your losses.
How Does Leverage Trading Work?
In order to trade with leverage, you must first open a margin account with a broker. A margin account is a type of account that allows you to borrow money from your broker in order to trade.
Once you have opened a margin account, you can then trade with leverage by simply placing a “leverage” order with your broker. A leverage order is an order that allows you to trade a larger position than you have capital for.
For example, let’s say you have $10,000 in your margin account and you place a leverage order to buy $100,000 worth of XYZ stock. This means that you are essentially borrowing $90,000 from your broker to finance the purchase of the XYZ stock.
Now, let’s say that the XYZ stock goes up in value by 10%. This means that your $100,000 investment is now worth $110,000. Since you only borrowed $90,000 to finance the purchase, this means that your return on investment (ROI) is 22%.
However, if the XYZ stock goes down in value by 10%, this means that your $100,000 investment is now worth $90,000. Since you only borrowed $90,000 to finance the purchase, this means that your ROI is 0%.
As you can see, leverage can both increase your profits and losses. This is why it is important to use leverage wisely and to always be aware of the risks involved.
How to Calculate Leverage
To calculate leverage, simply divide the total value of your trade by the amount of money you have deposited in your account.
For example, let’s say you have a $10,000 account and you place a trade to buy $100,000 worth of XYZ stock. In this case, your leverage would be 10:1 (100,000/10,000).
This means that for every $1 you have in your account, you are able to control $10 worth of stock.
What is the Standard Leverage Ratio?
The standard leverage ratio in the stock market is 2:1. This means that for every $1 you have in your account, you can control $2 worth of stock.
Some brokers offer higher leverage ratios, such as 4:1 or even 6:1. However, it is important to note that the higher the leverage ratio, the higher the risk.
What is Margin?
Margin is the amount of money you must deposit in your account in order to trade with leverage. When you place a leverage order, your broker will automatically set aside a portion of your account balance as margin.
For example, let’s say you have a $10,000 account and you place a 4:1 leverage order to buy $40,000 worth of XYZ stock. In this case, your broker will set aside $10,000 as margin (40,000/4). This means that you will only have $10,000 available to trade with for the duration of the trade.
The amount of margin required varies from broker to broker and from asset to asset. For example, some brokers may require 4% margin for stocks while others may require 6%.