Leverage trading is a strategy where you can borrow money in order to dramatically increase your potential returns (but also your losses). Leverage and margin is a common part of CFD trading but it’s a high-risk feature. If you’re keen to know more, let’s dive into it.
Leverage trading explained
In simple terms, leverage allows you to multiply the amount of money in your trade. For example, you can open a trade with £100 and ‘leverage’ it up to £200 or £300 by borrowing money.
Let’s use a couple of examples to explain. First, a normal trade without leverage. Imagine you open a £100 buy position on Apple stock. Incredibly, Apple stock doubles in price so you’ve now got £200. A simple trade and a great profit!
With leverage trading, you can multiply that trade even further. Let’s say you want to leverage it by a multiple of five. You still begin with £100, but you leverage your starting capital up to £500 by borrowing money from the broker. If the stock rises, your return is also multiplied by five. That £100 trade is now £1,000 if Apple stock doubles.
Returns are multiplied… but so are losses
However, the opposite is also true. In our first example (without leverage), if Apple drops by 20%, you lose £20. Bad news, but not the end of the world.
With CFD leverage, however, everything is multiplied by five. The 20% drop is multiplied by five to 100%. Your entire position is gone.
For that reason, leverage trading is risky and you should consider whether you can afford to lose your entire position. Of course, you should also use practices that allow you to limit your risk such as stop-losses to make sure this doesn’t happen. Click here to learn more about responsible trading.
What is margin?
Margin is the money you contribute to the trade. So, in our example above, your £100 is the margin and the rest is borrowed money. The margin acts as collateral so you can think of it like a deposit when you take out a loan.
If the trade goes against you, you may receive a ‘margin call’ if the account drops below the brokers’ margin threshold. In this case you’ll be asked to top up your account to bring it back above the margin requirements or sell other assets to cover it. In some cases, the brokerage will automatically liquidate your position to cover the costs and make sure they don’t lose money.
Leverage trading and margin trading can dramatically increase your potential returns when trading. However, please use this tool carefully as it can be risky. And remember, you can always start with a Demo Stryk account to practice before putting real money on the line.