How Leverage Trading Works and What You Need to Know
Understanding the concept of leverage can be a gamechanger to support traders in building informed strategic approaches to optimise outcomes. Our beginner’s guide explores how leverage works with real-world examples and recommendations on how to build a solid toolkit using the highest quality platforms and calculators designed to streamline trading.
Ideal for every trader interested in the opportunities associated with leverage when trading with crypto, forex, and on the wider financial markets, this guide will answer all your most pressing questions.
What Is Leverage in Trading?
The concept of leverage is built on a solid foundation designed to increase potential profits when trading and investing on the financial markets. Leverage is a trading tool defined as using borrowed funds, typically from a broker, to allow traders to access larger positions without the need to increase their initial capital outlay.
In other words, traders can use leverage to put down a small deposit (also known as a margin) but still gain exposure with larger positions to the underlying asset using broker funds. This allows traders to open positions worth significantly more than the money they deposit and access a new level of opportunities.
Leveraged trading supports wider trading ambitions without the pressure of large deposits. For example, in the case of 500:1 leverage, the trader would use $2 to control a position worth $500.
Another important concept to understand is the leverage ratio. This refers to the trader’s total exposure compared to the margin, considering the fact that the broker has loaned most of the position’s value amount. Due to this setup, the use of leverage can amplify both profits and losses – the smallest price movements can have a dramatic impact on outcomes.
If, for example, the market moves 0.2% in the direction against the trade, this could immediately cancel out a $200 margin on a $100,000 trade. If, however, the market moved 0.2% in a positive direction then the $200 margin would double to equal a $400 account balance.
How Does Leverage Trading Work?
When trading with brokers and on broker platforms, traders will typically see leverage information clearly displayed alongside the individual trade. For example, ActivTrades display “Leverage and Margin according to position (lots)” to help traders understand exactly how much leverage is available on different trade sizes and asset classes.
Below we have outlined a step-by-step example of how leverage is applied in practice using the example of 10x leverage with forex trading via ActivTrades.
- Set up an ActivTrades account: Open a margin-enabled account with your broker.
- Put down your deposit: You make a deposit of $1000 (your margin).
- Choose leverage: You select your desired leverage – in this case it is 10:1.
- Choose a trade and place it: You buy $10,000 worth of a forex currency pair.
- The broker takes action: The ActivTrades system reserves your $1,000 as margin and lends you the remaining $9000.
- Risk control is enabled: Depending on the individual trading profile, ActivTrades may set your margin requirements, stop-out levels, and liquidation rules to protect against substantial losses.
Where Is Leverage Used? (Crypto, Forex & More)
Leverage is used across the financial markets with both leverage currency trading and leverage trading crypto some of the most common examples. Leveraged trading has opened up the market to retail traders, allowing access to larger positions without the need for a high deposit.
Different markets have different margin (collateral) requirements in line with the broker, asset class, regulations and jurisdiction. Key examples* include the following:
- 20/30:1 in the UK for forex trading (depending on whether major or minor currency pairs) and 50:1 in the USA
- 2:1 to 5:1 in the USA/EU for cryptocurrencies
- Commodities CFDs - 10:1 for gold and 20:1 for oil.
Trading with CFDs is an increasingly popular way of accessing leverage particularly associated with forex, crypto, shares and indices trading.
*These numbers can be significantly higher if trading with offshore brokers or certain platforms.
What Are the Risks of Leverage Trading?
By putting down a fraction of the full value of your trade and trading with leverage, there are some inevitable risks involved.
The financial markets are inherently volatile and the use of leverage makes your trades even more vulnerable in this environment, meaning even the smallest price drops can lead to a dramatic loss in profits. In cases of major market drops such as a flash crash or if an extremely high leverage is chosen, this may mean losses exceed the initial margin/deposit and you may end up being in debt to the broker.
There is also the risk of liquidation which occurs when the market moves so far against your position that the broker automatically closes your trade to protect against further losses. This happens when your equity falls below a maintenance margin level - the greater the leverage, the greater the risk.
Another risk scenario to be aware of is the margin call. Just like with liquidation, brokers will issue a margin call if a trader’s account falls below the required maintenance margin. While some traders may deposit further funds to maintain their position, those who choose not to – or do not have the funds to do so – may see the broker force-sell their assets to cover losses.
How to Use Leverage Responsibly
In the context of the fast-paced financial markets where price swings and volatility are commonplace, all of the risks outlined above can lead to a very sudden and unexpected drop in profits. The good news is that there are a number of tools available to support responsible trading with leverage.
Negative balance protection and stop-loss orders are two of the most common techniques used to protect against great losses. Choosing low to medium leverage can also be good practice but this will depend on the individual trader’s risk preferences and trading goals.
Adopting more general good trading practice also applies here. Choose a reputable broker who will support you in building informed risk management strategies in your trading approach. This means only risking what you can afford to lose, consistently monitoring margin levels and adjusting where appropriate in line with your evolving trading journey.
Leverage Trading Tools & Platforms
There are a number of high-quality tools available to support trading leverage such as leverage trading calculators. Brokerage platforms including ActivTrades offer traders a range of tools and integrated platform features such as the progressive trailing stop and advanced CFD technology to help traders precisely understand and effectively manage the potential profits and losses associated with their chosen trades according to the rate of leverage chosen.
ActivTrades also offer access to demo accounts where traders can experiment with their leverage settings across different asset classes and lot sizes. By practising in a safe environment without any pressure, traders can learn how to manage their leverage risk in trading before entering the live environment.
ActivTrades traders can also access the highest-quality software platforms MetaTrader 4 and MetaTrader 5 including features such as balance protection and advanced educational tools to support informed leverage trading across a range of asset classes. Binance is another good research and education tool for those interested in effectively trading with leverage using crypto.
FAQs – Leverage Trading
What does leverage mean in trading?
Leverage is a trading tool that allows individual to access larger positions with just a small deposit, otherwise known as the margin. This is achieved by borrowing from their broker to access the full value of the position. Designed to optimise trading outcomes, leveraged trading is typically used in the financial markets especially with forex and crypto.
Is leverage trading risky?
Trading in the financial markets is inherently risky due to the unpredictable, fast-moving environment and trading with leverage makes your trades more susceptible to such risks. This is because your total profit or loss will be calculated in line with your full position size not your margin amount. However there are a number of tools available such as stop-loss orders to minimise risk and support good trading practice.
What’s the best leverage for beginners?
Low leverage from 1:1 (no leverage) up to 5:1 is usually best for beginner traders. This helps traders to become familiar with the concept, potential risks and rewards of using leverage in a low-pressure, lower risk environment. It also gives traders the skills necessary to effectively trade with leverage such as how to size trades properly and implement risk management tools.
Can I use leverage in crypto and forex?
Leverage trading cryptocurrency and forex is increasingly popular and widely available across different brokers and regions. Forex is more strictly regulated and broadly less volatile while crypto generally allows for higher leverage.
How is margin different from leverage?
While both margin and leverage are common financial trading terms, they represent different concepts. Margin refers to the initial deposit put down by the trader to open a leveraged position – it varies according to market and asset class and is typically expressed as a percentage of the trade size.
Leverage represents the “helping hand” received from the broker in order to access your desired trading position. It is expressed as a ratio of total position size to your margin - e.g. 10:1 – and it is a means of defining the size of your position in comparison to the margin put down to open the trade.
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