What is Leverage in Trading?
Leveraged trading, also known as margin trading, is a facility offered by many brokers, that allows the trader to amplify the value of his or her trades. That means opening positions much larger than his or her own capital would otherwise allow. This can increase the traders’ rewards, but it can also increase their risk too.
To use leverage in trading, the trader need only invest a certain percentage of the whole position. This can change depending on how much leverage the broker offers, how much leverage the trader would like to implement, and it also relies heavily on the regulatory authorities tasked with overseeing the online trading industry in that jurisdiction.
Leverage is commonly used nowadays, especially by more experienced traders, whereas newbies should exercise caution when it comes to using leverage.
“Leverage” usually refers to the ratio between the position value and the investment needed. For instance, at Capstonemarkets, traders can opt to use forex trading leverage of up to 500:1 and up to 200:1 for other instruments.
Let’s assume you are placing a trade for $50, if you use leverage of 500:1, this multiplies your trade 500 times. That means 50 x 400 =2500. Your trade is now worth $2500, rather than $50 and any profit you bring in would be reflected by that amount.
Unless a broker offers Negative Balance Protection (which Capstonemarkets offers, meaning stopping you out before your account goes into minus, then if you aren’t successful in that trade, your loss can be multiplied 500 times.
It’s also important to understand “Margin” here too. Note that in your account balance details, the margin is the most important number represented there. It is the amount of money you are putting forward and is almost like a security deposit held by the broker.