If you are active in the stock market, sooner or later you will stumble across the terms leverage, trading with leverage, leverage trading, margin trading or something like that. What that means exactly now, I will explain in this article.
Trading with leverage means borrowing money from your broker
Let’s say you have €1,000 in the account with your broker and want to trade the currency EUR/USD, then you can actually only buy €1000 EUR/USD. If you buy at $1.20 and exit at $1.21, then you have earned $10 (1000 X $0.01). If we now subtract the broker fees, then there is not really much money left from your profit, although one cent in currency pairs already means quite a decent price jump. So with a small account you don’t really get far here.
That is why most brokers offer margin trading, or trading with leverage. For example, if your broker offers you trading with a leverage of 100, then you can trade with a hundred times your account size. So if you were to trade with €100,000 instead of €1,000 and the price rises by one cent, your profit would be $1,000, a profit of almost 100%, after deducting broker fees.
What advantage do I have when trading with leverage?
Well, the advantage is obvious. The greater the leverage that your broker offers you, the more capital you can use and drastically increase your profits.
Of course, this only works if you are right with your trades and forecasts.
Especially with financial products that are not subject to such large fluctuations, as is the case with currencies, for example, people like to trade with leverage.
What disadvantage do I have when trading with leverage?
So now I come to the disadvantage of margin trading. If you trade with a large amount of leverage, you can lose a lot of money in the process. Often traders lose everything, or even more.
Especially beginners want to make money as quickly as possible on the stock market and therefore trade with borrowed money. Let’s take my example again and the price would not rise one cent, but fall from $1.20 to $1.18, then not only would all your money be gone, but you would also owe your broker $1,000. So trading with leverage should be done with absolute caution. For financial products with low volatility, such as forex, I can understand why People trade, but anyone who trades with Bitcoin and other cryptocurrencies with too much leverage is on very thin ice and a total loss is to be expected with high probability.
Only those who really know what they are doing and practice good money management may be able to profit from leverage trading. However, most beginners will sooner or later lose their money with it.