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 Capital Sands, 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 Capital Sands 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.

Pros and Cons of Leveraged Trading

Pros of Leverage

Minimises the capital the trader has to invest. Instead of paying the full price to open a position, the trader need only pay a small portion of it.

Some instruments are relatively inexpensive; meaning that the majority of traders can trade them easily. However, some are considered more premium, and their price reflects that. This can rule some traders out based on their available capital and their trading strategy. Instead of investing large amounts in order to participate in that market, one can use leverage and enjoy the fluctuations in the price of those more prestigious instruments.

Cons of Leverage

While leveraged trading or margin trading may require less capital outlay, which can be a major advantage for many traders, as mentioned earlier, it also comes with a loss risk. It is important to keep track of opened positions, and apply stop loss and other risk management tools, in order to prevent large-scale losses or to avoid a “Margin Call”. This is where the broker requests that the trader deposit additional money to bring it to the minimum amount.

Example of Leverage Trading – Retail Clients

Let’s look at another example, this time with Gold. The price of one Troy ounce of Gold is $1,327. The trader believes the price is going rise and wishes to open a large buying position for 10 units.

The full price for this position will be $13,270, which is not only a large amount to risk, but many traders do not possess such amounts.

With a 100:1 leverage offered by Capital Sands, or a 1% margin, the amount will decrease substantially. Meaning that for every $100 of worth in the position, the trader will need to invest $1 out of his account, which comes to $132.70/- only.

Long Position

A long position in trading CFDs is when a trader places a BUY trade. This means he expects the asset will rise or see an increase in its value over time. He will effectively BUY at a low price, and then SELL once the price rises.

Short Position

The short position occurs when the trader feels there will be a decline in the assets value and a ‘sell’ is selected, however, there is an intention from the trader to buy the contract back at a later stage. So he would profit from selling the asset at a higher price and then buying it back once the price has fallen. This might seem more of a complicated idea to grasp, but it comes naturally with practice. It also means that unlike when buying stocks you can trade CFDs even when markets are falling. This is a huge benefit to CFDs.

What are the Advantages of CFDs?

No Exchange fees – You do not own the underlying asset and do not acquire any rights or obligations in relation to the underlying asset. It is a contract between the client and Capital Sands, and you pay no commission.

Leverage trading – You need significantly less capital to open a trade in comparison to owning the underlying asset. Leverage is a double-edged sword, of course, as it can significantly increase your losses as well as your gains.

Multi-vehicle Investment – The ability to trade a range of instruments from the same trading platform.

Trade on both rising and falling markets – Open either short or long positions according to the market conditions and your trading strategy.

Hedging potential – A buffer for your trades if the trade is not going in the intended direction, you can open the equivalent position in the opposite direction reduce the risks.