What Is Leverage Trading?
Leverage trading is the benefit of trading larger sums of money than you have in your account.
Day trading is a lucrative opportunity. Many people have learned to make a full-time income as a trader. And those that really commit to the process can go on to build massive wealth.
What is leverage trading? Leverage is the benefit of trading larger sums of money than you have in your account. You are essentially borrowing money to make bigger trades. And if you make the right call, you'll earn larger profits.
The Problem With Unleveraged Trading
Successful trading is all about risk management. Those who trade for a living know that they shouldn't trade more than 1% or 2% of their account balance on a single trade, otherwise they'd wipe out their account balance.
So if you have $10,000 in your trading account, an individual trade should be limited to risking $100 or $200 at most. But such a small trade would vastly limit your profit potential. And profits would be further reduced by the commission on each trade.
To make trading worth it, you want to be opening larger positions. That's where leverage comes in handy.
What Is Leverage Trading?
So what is leverage in forex trading, stock trading, and crypto trading? It's the process of controlling larger amounts of money with only a small amount of money in your account.
Trading brokers offer leverage as a way of amplifying your buying power when making a trade.
For example, if a broker offers 1:10 leverage, that means that for every $1 you have, you can have a buying power of $10.
If your broker offers leverage of 1:50, then for every $1 you have, you'll have a buying power of $50.
It's not uncommon to see some brokers offering leverage as high as 1:500.
So if you have an account balance of $1,000 and a broker offering 1:20 leverage, you can effectively trade with a total of $20,000.
So with your small amount of money, leverage offers you the opportunity to make much larger trades than you can afford on your own. This means the profits you can earn can be much larger. But the risk is also higher.
And there are rules regarding how you use leverage. Failing to meet margin requirements can result in your positions being liquidated and you losing all your money.
Leverage Trading Example
Here's a simple example of a successful leveraged trade.
You have an account balance of $1,000. Your broker offers 1:20 leverage. You can enter a trade with a $20,000 position.
Say you buy 1,000 shares of a stock, priced at $20. If the price increases by $0.50, and you sell all your shares, you would have made a profit of $500.
By closing your position, your original $1,000 is returned to your account, along with your profit of $500.
But if the trade went against you, and share prices decreased by $0.50 before closing your trade, you would have lost $500.
Without leverage, could have bought 50 shares of the same stock. The same price movement would have yielded either a profit of $25 or a loss of $25.
How Leverage Trading Works
When using leverage, you'll need to maintain a certain level of margin in your account. Margin is the balance required to open a leveraged position.
So if your broker offers 1:20 leverage, and you open a trade with a $20,000 position, your margin (the cash you are putting up as a deposit) would be $1,000. This amount of money is locked up as long as your leveraged position is open.
So you won't be able to use this $1,000 for another trade until you close your current position.
If a trade moves against you, your margin will decrease. If your margin reaches a certain level, your broker will issue a margin call. They will alert you that your margin level is low, and unless you add to your position or close your position, you run the risk of liquidation.
When a trade moves far enough to wipe out your position, the trade will be closed automatically, resulting in the loss of all your margin. Setting reasonable stop losses on your trades is one way of preventing the total loss of your margin.
Leverage Trading Tips
So what is leverage trading in crypto versus stocks? Leverage is the same regardless of which asset you are trading. It works the same in crypto as it does with stocks, forex, and even commodities like oil.
Most online brokers offer leverage trading. But how much they offer may differ. Some platforms might cap out at 1:50 leverage, while others offer 1:100 or up to 1:500.
But while your broker might offer you large amounts of leverage, it doesn't mean you should use it all. Using the maximum amount of leverage available increases your risk of liquidation.
Your highly leveraged positions are more sensitive to price movements. Say you buy a stock valued at $100.
With a $1,000 account balance, you could buy 10 shares. If the price per share decreases by $1, your balance is reduced by $10.
If you are using 1:100 leverage, and your position is worth $100,000, then a small $1 price movement in the wrong direction is worth $1,000.
A $1,000 loss in this case can wipe out your account balance.
So while profit potential increases dramatically, so does the potential for losses. Newbies often enter highly leveraged trades thinking that one successful trade can make them rich. But one bad trade can wipe out their account in just a few moments.
Therefore, leverage is best used once traders are experienced and are profitable without leverage. Leverage works by amplifying a trader's ability.
If a trader wins more than he loses, leverage multiples the gains. But if a trader loses more than they win, leverage only amplifies their losses.
Become Profitable First and Then Add Leverage
So what is leverage trading? Using leverage as a trader amplifies your buying power. With leverage, you can control larger quantities of assets, without putting up a lot of capital.
The upside is increased profits if you win. The downside is increased losses if you don't know how to manage risk. Before using leverage, you need to learn how to become a successful trader. It takes a lot of practice to develop profitable trading strategies.
But if you want to shorten the learning curve and speed up the process, you can join the Spiking Wealth Community to get all of the tools and resources you need to take wealth generation into your own hands.
Dr. Clemen Chiang, Ph.D., has spent over 20 years as a Wealth Coach to more than 50,000 students. His proprietary methodologies and strategies help people all around the world. Come and learn the trading strategies you should be implementing from the Expert Teacher himself, Dr. Clemen Chiang!
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