Leverage is a tool that allows you to have a much larger exposure to the market than the amount you deposited to initiate the trade. CFDs and other leveraged products magnify your potential profit – but also your potential loss.
Leverage is an important feature of CFD trading and maybe a very powerful weapon for a trader. You may utilize it to profit from small price movements, ‘gear’ your portfolio for greater exposure, or make your money go farther.
Leverage works by using a deposit known as margin to offer you increased exposure to an underlying asset. Essentially, you put down a portion of the total value of the trade, and your supplier lends you the rest. The leverage ratio is the ratio of your entire exposure to your margin.
What is a Leverage Ratio?
The leverage ratio compares the total exposure of your transaction to the margin requirement. Your leverage ratio will vary depending on the market you are trading with, who you are trading with, and the size of your position.
Using the earlier example, a 10% margin would give the same exposure as a $1000 investment with a $100 margin. This results in a leverage ratio of 10:1.
The lower the leverage available to protect your position from rapid price movements, the more volatile or less liquid the underlying market. However, extremely liquid markets, such as forex, may have extremely high leverage ratios.
For a $1000 initial investment, here’s how different degrees of the leverage effect your exposure (and consequently your profit potential and maximum loss):
When researching leveraged trading providers, you may come across higher leverage ratios – however, employing excessive leverage might have a negative impact on your positions.
Benefits of using leverage
Leveraged trading may be a very powerful trading tool if you understand how it works. Here are just a handful of the advantages:
Big Profits: To receive the same profit as in conventional trade, you simply need to put down a fraction of the deal’s value. Because profits are calculated using the entire value of your position, margins may multiply your returns on successful trades – but also your losses on unsuccessful ones.
Gearing Opportunities: Leverage may free up capital that can be committed to other investments. Gearing refers to the ability to increase the amount of money available for investment.
Going Short to the Market: Using leveraged products to speculate on market movements enables you to benefit from both falling and rising markets – this is known as going short.
24-hour dealing: Though trading hours vary for each market, some markets, such as important indices, forex, and cryptocurrency markets, are available for market 24 hours a day, seven days a week.