It is possible to use borrowed money to buy a higher number of assets to earn more profit. But to know how you have to understand what is leverage in trading. Simply explained, it is one of the best tools to win more money and pay lower costs.
Using leverage conveys a big responsibility. Thus, you need to understand how this works to take advantage of this tool. For this reason, at MDC Trading Academy, we wrote this article for you! To teach you how to use leverage the right way.
Keep on reading! Learn the basics of leverage in trading, how it works, and some of my best tips for you.
What is Leverage in Trading?
Leverage in trading is a financing mechanism that allows you to use borrowed capital, so you might buy more financial assets. The objective is to use the borrowed money to profit more in your trading activity.
Thanks to leverage, you can trade higher positions without paying the total cost. Your broker is the one who will lend you the money, that way you can negotiate your trades by investing just a fraction of the net value of the transaction.
It is a tool that helps you multiply your profit by investing a lower percentage. It is one of the best opportunities in financial trading to increase the market participation of traders with low amounts of capital.
How to Trade With Leverage?
Using leverage is an excellent way to win more money. Nevertheless, you will need a trading strategy complemented with management risking tools. It is a way to reduce your exposure, so you do not lose all your money.
Order types are other tools you can use to reduce your risk. They control losses and secure profit while trading the financial markets.
Trading psychology is also crucial while using leverage. It is a method to understand how your feelings influence your state of mind while trading. Being aware will help you be more autocritical and analytical before taking any decision.
At the end of this article, I will tell you the best place to learn about all of this.
How Does Leverage Trading Work?
Leverage works like any other type of debt, but in financial trading, the one who lends the money is the broker you are using to operate. The intention is to give you more capital to buy a higher number of financial assets instead of the ones you could buy with your money.
To help you understand this better, let me explain with an example. Imagine you have $1000 available in your trading account to buy oil future contracts. The price for each contract is $10 (in this scenario); thereby, you could buy 100 contracts.
What will happen if instead of 100 contracts, you want to buy 1.000 contracts? Well, you can use leverage. In this case, the broker would lend you the money that you need. It means that, of the total cost for the 1.000 contracts of $10,000, you would only pay 10 % ($1,000), and the 90 % left ($90,000) you can pay it with leverage.
If the price of the contracts rises to $12, you could earn a profit of $2,000 by selling them and investing a total of $1,000.
However, if the price drops to $9, you could lose $1,000 by selling them, losing your capital for this negotiation.
How to Calculate Leverage Trading?
To calculate it, you only need to take the percentage of the initial margin your broker requires of the asset’s value. The remaining is the amount of leverage.
An initial margin consists of the proportion of capital you need to invest, so you can negotiate a trade position.
In futures trading, the typical proportion indicated by the Chicago Mercantile Exchange (CME) is 3-12 %; for instance, if you want to trade with an E-mini S&P 500 futures contract with a $103,800 value, you will need to invest an initial market of at least $5,060 (4.8 % approximately).
The percentage for the calculation can vary from the financial market to market.
How can Leverage Impact Your Trading?
Leverage can give you benefits but can also have consequences:
In terms of profit, you can win more money, but your exposure to risks will increase, meaning you can lose more money.
You can buy high-value financial assets, so leverage opens opportunities for you, making the market more affordable to you.
You must remember that leverage works the same as any other debt, so you will need to pay the amount borrowed from the broker.
Tips for Using Leverage Successfully
To use leverage successfully, the first thing you need to do is understand how it works. Once you are clear, consider the following:
- Check the leverage options available by your broker and the requirements. Because you are using borrowed money, most brokers will require you to own enough capital to cover the possible losses.
- Add to your strategy tools that can help you against risk exposure.
- Take advantage of simulators to practice the use of leverage while trading.
- Consider the risks involved and be prepared to trade with money you can afford to lose.
- Use tools to help you analyze the market, such as indicators and charts, so you can back up any decision you take.
- Consider the margin requirements of the market you want to operate.
Even if leverage is one of the best tools to earn money, have enough experience before trying it.
Learning from a mentor can be very helpful for understanding how to use leverage in your trading activity. As well, having a proven trading strategy can guide you to success. At MDC Trading Academy, we have the best training for you: join our Senior Trading Program and learn how to use leverage and other tools to become a professional trader!
Our mission is to develop profitable traders who can make a living out of this! Do not miss this chance!
FAQ
Should I Trade With Leverage?
You should trade with leverage only if you have experience operating the financial markets. Be aware that, even though it can multiply your profit, it can also increase the amount of money you can lose.
In the end it is your own decision. If you have enough capital that you are willing to lose and leverage suits your trading strategy, you can consider using it.
Why Use Leverage in Trading?
Leverage is a great tool to increase the number of securities you can trade to increase your profit. It is a way to take advantage of your capital: you can negotiate with assets at a lower cost.
Plus, it can give you access to trade with high-value securities.
Difference Between Margin and Leverage Trading?
The margin is the fraction of money you need to invest to use a certain amount of leverage. Leverage is the capital your brokers borrow you to buy some assets.
For example, if you want to trade with a future contract with a value of $10,000, entering this position can require a 10 % margin ($1,000). That being said, the leverage will be the remaining 90 % ($9,000).
Is Leverage Trading Worth It?
Yes, it can be worth it if you do it correctly and responsibly. It is an opportunity for traders with low amounts of capital who are finding to profit more.
Be sure to understand how leverage works, practice in a simulator, and have enough capital to confront possible losses.
Manny Cabrera
Stock Market investor since 1990. Professional futures trader since 2008. Finance Specialist and Systems Engineer; he worked for more than nine years on Wall Street. Head Trader and Co-Founder of MDC Capital Group with vast experience mentoring traders. Architect and designer of the MDC methodology. His passion is to transform lives through trading.