There are a lot of retail traders nowadays who cannot afford to take on huge deposits to gain an ample amount of positions in the market. That’s when leverage becomes handy. It is your broker’s way to facilitate the needs of their users.
Before, trading is all for financial institutions like banks and other similar organizations. They are the market players and they always will. But thanks to leverage trading, small retail investors are given the chance to participate in the market. Since they don’t have the capacity to shed a huge amount of capital for their trading account, they can use leverage and take advantage of it in their own way.
Leverage is a tool that allows traders to take on larger market exposure without depositing a huge amount of money to open a position. Leveraged products like CFD surely magnify your profits, but just like any good thing, there are also and cons that you are obliged to embrace. Leverage also mirrors loss just as it mirrors gains.
If you have an interest in CFD trading, you must also learn about leverage and how it works, before you jump to borrowing money from your broker. Using is against small price movements will give you an upper hand. It helps gear up your portfolio into a greater exposure. It can even take your capital further than you can afford.
Leverage uses a deposit called margin, which allows you to have increased exposure to the underlying asset. For short, you put a small amount so you can trade in full value. The rest of the amount is what you loan from your broker.
You will also introduce to leverage ratio. It is the overall exposure to margin. For instance, you are about to buy 1000 company shares at the price of 100p. Originally, you can open a trade after paying 1000 x 100p, excluding the charges and commission. As the company shares go up to 20p, the 1000 shares that you have will now be worth 120p each. Closing your position this time will earn you a $200 profit out of your original $1000. On the other hand, if the market falls at 20p, instead of gaining $200, you will lose $200.
Most leveraged products use derivative products; this means that you can trade using an instrument that has the value of the underlying asset, instead of ownership of the underlying asset. Leverage trading is very common among retail traders.
It is a bet as to the direction where the market will move. If the market goes in the direction of your choice, you will gain profit and losses if it goes against your prediction.
It is an agreement held between the broker and the trader to exchange the price difference of a financial product from the time that you opened the position until you close it.
Other leveraged products include futures, options, and other exchange-traded funds (ETFs). Although they are working differently, they give the same advantage to traders when it comes to increasing profit and also obtaining losses.
To say it simply, the margin is known to be the amount in which you have to secure to be able to open a position. The margin rate will depend on the broker’s margin requirement. As for the rate, it will all be based on the trading instrument, the liquidity, and the volatility of the market.