Stock trading with leverage can form a key pillar of your strategy and this guide will tell you all you need to know about how it works, the pros and cons and the different instruments available to you. Read on to find out more about ratios, margins and for practical examples that explain how leveraged stocks work.
Leverage is a tool that enables you to increase your market exposure. It allows you to take up larger positions while only putting up a proportion of the capital that would be required to open that same position if you were investing directly. You can use it to access a wide range of asset classes but for the purposes of this guide we will focus purely on stock trading with leverage.
When you trade stocks using leverage, you create the possibility of magnifying your profits but there is also the risk of magnifying your losses. That's because you are exposed for the full position - not just the margin - and the amplification of those profits or losses will depend on your leverage ratio. Let's define what those key terms mean.
The margin refers to the amount of capital that you need to put up in order to open a leveraged position. This is known as the deposit margin and will typically be displayed as a percentage. The margin requirements will differ depending on your broker and the asset that you are looking to trade. For example, the margin for leverage trading stocks might be 20% whereas for trading forex it might only be 5%. Here's a practical illustration using those figures:
Then there is the maintenance margin, which is the amount of capital that you need to have in your account in order to keep open a position, in the event that you start to make a loss on a trade. If your losses exceed your maintenance margin, your broker will issue a notification, known as a margin call. If you fail to act, your position could be closed down.
Find out more in our in-depth guide to trading on margin.
The degree of leverage at your disposal will be displayed as a ratio. For example:
The first number in the ratio reflects by how many times your margin will be multiplied. Let's assume that you have $1,000 of capital to put up as your deposit margin. Using the leverage ratios quoted above, your total position value would be:
Find out more about leverage trading with Tradu.
You can use leverage in stock trading to go long or short, so you have the potential to make a profitable trade in both bearish and bullish markets - as long as your prediction proves correct. Below is a theoretical example of a long position involving Company XYZ:
It's important to remember that, when stock trading with leverage, your profits and losses are calculated based on the full value of your position, not just the initial amount that you put down as a deposit margin.
Typically when using leverage to trade stocks, you will use a derivative instrument. This means that you are not taking ownership of the underlying asset - so, in the example of Company XYZ used above, you are not acquiring shares in that business. Instead, you are simply speculating on the performance of its share price. One of the primary derivative products for stock trading with leverage are contracts for difference (CFDs).
This is an agreement between a buyer and a seller to exchange the difference in an asset's value between the time when the contract opens and when it closes. There is typically no expiry date on CFDs, although there are some exceptions.
Find out more in our detailed guide to CFD trading.
Trading stocks with leverage offers a number of potential advantages:
It's important to bear in mind that there are no guarantees of success when stock trading with leverage. Some of the risks include:
Some of the risks include:
Unleveraged trading, for example investing directly in a company's shares, is an alternative to stock trading with leverage. Unlike leveraged trades, you are taking ownership of the underlying asset. It also means that you are required to put up the full value of the position and can only make a profit if the share value increases.
One positive of unleveraged trading is that your losses are finite. There is no leverage ratio to take into account, so any losses are capped at the amount which is equal to what you initially committed to open the position.
Yes, you can start stock trading with leverage today. We offer a CFD trading account through our proprietary platform, which features a host of outstanding analytical tools to help you to monitor the markets, analyse trends and shape your strategy.
Once you've opened your account, decide which stocks you want to trade and make sure that you understand our leverage ratios, margin requirements and their implications for your position. If your prediction proves correct, you stand to make a profit which could create further opportunities for future trades.
Open an account with Tradu today.