What is leverage in trading?
So, what does leverage mean? Leverage is the ratio applied to the margin amount to establish how big a trade is going to be placed. Understanding margin and leverage and the difference between the two can sometimes cause confusion. It is important to realise that margin is the amount of capital that is required to open a trade. Learn more about margin accounts.
A leverage of 10:1 means that to open and maintain a position, the necessary margin required is one tenth of the transaction size. So, a trader would require £1,000 to enter a trade for £10,000. The margin amount refers to the percentage of the overall cost of the trade that is required to open the position. So, if a trader wanted to make a £10,000 trade on a financial asset that had a leverage of 10:1, the margin requirement would be £1,000.
Leverage can sound like a very appealing aspect of trading, as winnings can be immensely multiplied. But leverage is a double-edged sword – it is important to remember that losses can also be multiplied just as easily.
It is important for all traders to bear in mind the risks involved in leveraged trading. Many traders see their margin wiped out incredibly quickly because of a leverage that is too high. Novice traders should be especially careful when practising margin trading. It is best to be more prudent and use a lower leverage. A lower leverage means traders are less likely to wipe out all of their capital if they make mistakes.