What is leverage in stock trading?
- Leverage in stock trading includes borrowing money to increase the number of shares involved in a transaction beyond the capital the investor invests.
- For new stock traders, it is best to understand the potential benefits and pitfalls of investing in the stock market with leverage.
For stock traders, one of the not-so-secret tools they can use is leverage, which is their ability to borrow money from a broker to increase the buying power they hold.
For traders relatively new to the markets, it is best to first understand the benefits and potential pitfalls of this type of investment before being seduced by the promise of big returns.
Trading with leverage
Leveraging in stock trading involves borrowing money to increase the number of shares involved in a trade beyond the amount a trader is initially willing to buy with his own money. It works by increasing exposure to the underlying asset through a deposit, also known as margin, to secure the borrowed funds.
Especially for stock traders with limited capital, leverage trading is a powerful tool that can help investors maximize returns on even the smallest price changes, grow their capital exponentially, and increase their exposure to desired markets.
Leverage can be used when buying on margin, as previously mentioned, or when buying futures and options. It can also be used for exchange-traded funds that use leverage to change their performance and to trade derivatives.
Pros and cons
Simply put, leverage in the stock market can increase investment returns every time the stock price rises (when buying). At the same time, it could also increase the loss if the alternative occurs. For example, if a trader buys a stock at $100 using $50 out of pocket and $50 using leverage, a price increase to $150 for the stock will mean a 100% return for the trader. (after selling the stock and returning the borrowed funds). However, if the price drops to $50, instead of only losing $50 if the trader only buys with cash on hand, they will lose 100% if leverage is used.
One of the advantages of using leverage when trading the stock market is that it can be without interest or commission obligation, although it is still a loan. This gives the trader the freedom to use the “loan” in any way while trading.
Another good thing about leveraged trading is that it increases the amount of money a trader can use to invest in different markets. Leveraged traders can also increase their profits through profitable trades and gain access to investments that would have been too expensive or prestigious if targeted using cash alone.
Article by Mark O’Donnell » Black Bull Markets » Official Site
BlackBull Markets is a true ECN broker, Without Dealing Desk, offering institutional quality products and services. Proprietary trade order aggregation system that reduces spreads while increasing execution speeds and available markets. Personal account support with a personal account manager with 24/6 live support.
Disclaimer: The information and opinions contained in this report are provided for general information only and do not constitute an offer or solicitation to buy or sell currency contracts or CFDs. Although the information contained herein has been obtained from sources believed to be reliable, the author does not guarantee its accuracy or completeness and assumes no responsibility for direct, indirect or consequential damages that may arise as a result of any reliance on such information.