Saturday, April 20, 2024

Why is leverage both beneficial and dangerous for traders?

As you know, on any exchange, trading is carried out to buy or sell financial assets. At the same time, each trader does not set himself the real goal of buying an asset or selling it, since the interest of exchange trading is to make money on the exchange rate difference of trading instruments.

Earlier, at the time of the birth of financial markets, trading was carried out between large financial companies and only a trader with a large amount of money could be a participant in the trade.

Today, thanks to margin trading, the ability to trade on exchanges is available to every beginner with a small capital, starting from $100.

What is Leverage in Simple Terms?

The term leverage is the ratio of a trader’s deposit to the amount of money he trades with. In simple words, this is financial leverage or a broker’s service that provides a trader with borrowed funds that exceed his deposit by a certain number of times (10, 100, 200, etc.)

If an investor with a large deposit can buy the required number of lots for trading, then no leverage is issued to him. The leverage size is different: the minimum is from 1:1, the maximum is 1:1000, but sometimes it is 1: 5000.

Leveraged Trading Opportunities

On the exchange markets, a trader buys shares not for his own purposes, but for the opportunity to make money on the difference and changes in the price rate. And the more funds he has in circulation, the greater the estimated income. To do this, he resorts to the need for margin trading.

In the modern world of trading almost every broker has leverage available for customers. This is a tool that helps traders to execute large traders and increase their profits. However, the size of leverage could vary among brokers. Generally it is not advised to trade with 1:1000 leverage if you are a beginner. Choose lower leverage. In this hotforex broker review you will find out information about a broker that has a decent leverage and all the necessary conditions to conduct profitable trading.

Let’s say that an investor trading on the Forex market has opened a deposit of $1000 and wants to work with a volume of one lot for the EUR/USD pair. With such a desire, the trader’s deposit should be $100,000, because one lot is equal to 100,000 units of this currency. He will not be able to trade with his deposit.

But using the services of a broker, in the form of a loan in the amount of 1:100, the investor’s activity becomes possible. In this case, a deposit in the amount of $1000 is taken from the trader’s account, and the remaining missing funds 99,000 are provided by the broker in the form of a loan.

In this case, the trader has a chance to significantly increase his earnings, since trading with the provision of margin is really very convenient and profitable.

But it should be borne in mind that in case of an unprofitable transaction, the risks of losses will be no more than the entire size of the deposit. The company provides borrowed funds only for the ability to manage assets, but the investor is not able to “draw down” the exchange loan.

Cons and Risks

The tool is convenient and accessible – it opens without statements and special requests. Brokers often offer these services initially. However, the investor’s losses grow proportionally. For example, the same 100 shares for 1,000,000 USD may lose in price and cost already 9,000 USD per share. With a decrease of just 1,000 USD, losses on 100 shares will already amount to 100,000 USD. That is, the investor will lose all equity capital at once. In this case, the broker will not go into the negative – his requirements will include the minimum loss-making threshold. That is, when the minimum set price for a share is reached, the transaction will close, and the broker will return its allocated funds. Therefore, using leverage, it is necessary to distribute funds over several types of shares.

The size of the leverage and the conditions of the loss threshold depends on the shares themselves and their investment attractiveness. Usually, with minimum capital, a larger loan is issued, and with a large capital – a smaller one. Leverage allows you to increase your own funds in order to trade further without such a service. It is similar to a loan to start a business, only the broker does not charge a commission on profits as a bank does. However, without proper preparation and study of the investment business, significant losses can be incurred. Therefore, one should enter into an investment business with a trusted broker and with the necessary knowledge.

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