Leverage Trading

Leverage allows you to open larger trade positions from smaller deposits, amplifying your potential profits or losses. Learn the intricacies of how it works to manage your risk and take leveraged positions with confidence.

Leverage is a powerful tool for traders, heightening your levels of risk and reward in equal measure. Below, learn the key things that you should know about leverage to use it to your advantage and keep your risk under control.

• What is leverage trading?
• How does leverage trading work?
• What are the different ways to trade with leverage?
• What markets can you trade with leverage?
• What are the benefits of leverage trading?
• What are the risks of leverage trading?
• How to manage your risk when trading on leverage
• When to use leverage in trading

What is leverage trading?

Leverage is a popular feature of trading that enables you to open positions worth potentially far more than the capital that you initially deposit. You can use different amounts of leverage – for example 5x, 20x or even 100x your deposit – across a range of financial markets and it will depend on the regulatory restrictions within your jurisdiction. Find out more about leverage limits with Tradu.

You'll amplify your potential profits or losses in the process, with the outcome based on your full trade size and not your deposit. This means that leverage can work for or against you in equal measure, making an in-depth understanding of market conditions, position sizes and risk management essential.

How does leverage trading work?

When using leverage, your deposit represents a fraction of the total trade. The remaining capital required for the trade size that you want is provided by a broker like Tradu, similar to a loan but without incurring interest.

Truly understanding how leverage works in trading is easier with an example. Let's say that you have $10,000 available in your trading account and want to trade a popular stock such as Apple.

If you used the funds in your account as the deposit and opened a position with 5:1 leverage, your full position would be worth $50,000. We'd provide the $40,000 required to multiply your deposit by five. Your profits or losses will be calculated from the $50,000 trade size, not your $10,000 deposit, so they could easily outweigh your deposit.

What's the difference between leverage and margin?

Leverage and margin are closely related terms, so much so that you might see them used interchangeably. They are slightly different, however.

Leverage is the concept of borrowing money to open larger trades, while margin is the deposit that you need to facilitate a leveraged position with a broker. In the example that we used in the section above, the $10,000 deposit is your margin amount.

You may see references to different types of margin:

• Deposit margin is the amount that you need to open a position of a certain size.
• Maintenance margin is the amount that you need to keep open a position, sometimes referred to as used margin once you've paid it to a broker.
• Usable margin is the amount that you have available in your account with which to open new leveraged positions.

What's leverage ratio?

Leverage ratio is a measurement of your trade's total size compared to the margin that you need. In the same example, the leverage ratio is 5:1, meaning that your position is worth five times your margin.

In reality, your available leverage ratio can vary depending on:

• The market that you want to trade
• With whom you're trading it, i.e. a broker such as Tradu
• The regulations within your jurisdiction

Markets with higher volatility or less liquidity tend to have lower leverage ratios available to guard against the dangers of quick, significant price movements and wider spreads. Alternatively, popular markets such as forex – with over $7.5 trillion in daily transactions – often provide higher leverage ratios.

You can use the leverage ratio to calculate your full position size when assessing a trade. Simply multiply your margin amount (shown as 1 on the right of the ratio) by the leverage amount (shown as a variable number on the left of the ratio). It's this figure that determines your profits or losses, depending on the trade's outcome.

How unleveraged trades work

With an unleveraged position, you'll need to commit the full value of your position upfront. This means that you'll need to provide greater capital to achieve the same exposure as a comparative leveraged position (or open smaller positions if your budget won't allow it). Your risk will be capped, however, as – unlike a leveraged trade – your potential losses will be equal to the amount that you pay to open the position.

Using the previous example again, you'd only be able to take a position on Apple stock worth $10,000 based on the funds in your account (though most traders don’t use their entire account balance as margin). Your potential losses cannot exceed this $10,000, however.

How do you trade with leverage?

Leverage trading commonly uses contracts for difference (CFDs), which are a financial derivative product.

CFDs allow you to speculate and potentially profit from price movements in both directions, meaning that you can trade both bullish and bearish market conditions with leverage. You won't actually own the underlying asset, but your profits or losses still correlate with its performance.

A CFD is an agreement between you and a provider – such as Tradu – to exchange the difference in price of your chosen underlying asset between the times at which you open and close a position. Read our guide to CFDs.

What markets can you trade with leverage?

Interested in particular markets? You may be wondering if you can trade stocks with leverage, or if you need leverage to trade forex, for example. The good news is that you can use leveraged products on a wide range of asset classes and markets, allowing you to build a diversified portfolio.

Just keep in mind that different financial markets typically have different available leverage ratios due to their liquidity, volatility and jurisdiction.

• Stocks: Speculate on the share price of publicly traded companies around the world, following earnings reports and other factors to gauge their outlook. We can offer leverage ratios of up to 1:20. Read our guide to stock trading.
• Forex: Trade on foreign currencies as they rise and fall in value comparatively based on monetary policy, economic indicators and other influential factors. We offer leverage ratios of up to 1:400. Read our guide to forex trading.
• Indices: Speculate on the price movements of stock market indices, providing quick exposure to broad economies and sectors. We offer traders leverage ratios of up to 1:400. Read our guide to index trading.
• Commodities: Take leveraged positions on commodities that you use or see every day from oil and gold to coffee, influenced by the constant fluctuation of global supply and demand. We offer leverage ratios of up to 1:400. Read our guide to commodity trading.
• Crypto: Trade on the volatility of established and emerging cryptocurrencies, gauging sudden and sometimes drastic movements due to media coverage and other factors affecting sentiment. We offer leverage ratios up to 1:4. Read our guide to crypto trading.

What are the benefits of leverage trading?

When used carefully, leverage can prove a powerful tool that enhances your trading prospects in several ways:

• Amplified profits: Leverage can significantly increase the capital that you can invest and control in a market. If you make the right call, you'll potentially boost your profits far beyond what you'd achieve with an unleveraged position.
• Gearing: Putting up smaller amounts of capital than you’d otherwise need can free up funds for you to commit to other investments. This tactic is commonly known as gearing among traders.
• Go long or short: Leveraged products like CFDs allow you to profit from falling markets as well as rising ones, known as going short. Conventional unleveraged investments only generate profits from rising markets.
• Extra trade opportunities: While trading hours vary between financial markets, many are available to trade with leveraged products around the clock and out of hours with Tradu, increasing your opportunities to profit.

What are the risks of leverage trading?

Leverage heightens your risk as well as reward, so it's wise to be aware of the following downsides and take appropriate precautions:

• Amplified losses: Making the wrong call on a leveraged trade can quickly work against you, with your losses potentially outweighing your margin. Make sure to consider each trade based on its full downside potential, not your much smaller deposit alone.
• Overnight charges: Using leverage means effectively borrowing money from a broker, incurring small fees if you want to keep positions open overnight. In this regard, leverage can be more suited to short-term day trading strategies.
• No shareholder rights: Using leveraged products means that you won't own the underlying asset that you're trading, eliminating or affecting common shareholder rights in the stock market such as voting power and dividends.
• Margin calls: If a position moves against you and the capital in your account falls below a minimum amount required to maintain it, you may receive an alert known as a margin call. This requires you to either add capital to keep the trade open, or close the position.

How to manage your risk when trading on leverage

Given the heightened risk of trading on leverage, it's important to use risk-management strategies and tools to limit your loss potential.

• Understand your position size: Make sure to calculate the full value of any leveraged trade rather than focusing on your margin alone. You should only commit amounts with which you're comfortable, using smaller leverage ratios where appropriate and possible, rather than the maximum leverage available.
• Stop-losses: Stops are features you can add to a position to restrict losses by automatically closing it if the market moves against you to a certain price. If a market moves quickly however, there's a risk the price could move beyond your stop before it's triggered.
• Guaranteed stop losses: These features work in the same way as stops but with a guarantee of execution at exactly the level that you set, regardless of gapping or slippage. You'll pay an extra (small) fee if your stop is triggered.

Other useful tools for limiting losses include price alerts and limit orders. Read our guide to risk management in trading.

When to use leverage in trading

As a trader, you should generally only use leverage – especially higher ratios – when you confidently judge the advantage to be on your side. Carrying out robust fundamental and technical analysis is key for informing your trade decisions based on which way markets appear to be heading.

You may also set rules about the amount of risk that you're willing to accept as a percentage of your trading capital, for example 3%. If you calculate that a leveraged position poses a level of risk beyond your tolerance – i.e. the potential losses exceed how much capital you're willing to risk in one trade – you may choose to reduce your leverage ratio or margin amount.

Most traders create a diversified portfolio to spread risk rather than committing all their capital to one trade.

Now that you know what leverage trading is and how it works, are you ready to start using it to your advantage in a range of exciting markets? Sign up for a Tradu account online today.