Leverage and Margin

To trade successfully in the long-term, investors must be familiar with the basic terms and concepts of the trading field. Two of the most common – and most important – terms are leverage and margin.

In this article, Ubrokers introduces you to the concepts of margin and leverage.

What is leverage?

The word ‘leverage’ comes from the word ‘lever’. A lever is a mechanical instrument that allows you to lift or move a very heavy object by applying a small force. In the same way, leverage gives an investor the ability to control a large investment amount with a small deposit.

In essence, leverage is borrowed capital lent by the broker to you, the investor. The factor by which your exposure (the real value of the position you take) compares to your deposit is the leverage ratio. The exact leverage ratio varies but is often a factor of 2, 5, 10 or 20. It depends on the derivative being traded, the type of account you have with your trader, and the position that you take.

Depending on the electronic trading platform and the broker, there may be a commission and brokerage charged on the leverage and the trade. There is also a spread that applies to all such investments. A spread is the difference between the market price and the price that you are charged. Some brokers replace commissions with a fixed spread.

Leverage is a universal feature of CFD (contract for difference) trading. While it gives you unprecedented exposure in the market, a CFD also magnifies risk and reward by the same margin. Remember, leverage is the initial deposit required to take a market position, however you are still liable for the entire amount of the exposure if the market moves in the wrong direction.

What is Margin?

The initial deposit that gives you leverage is called the margin. The margin varies for every instrument that you trade.

For example, say you have $1,000 in your trading account. You could buy CFDs on the USD-EUR forex rate for a margin of $700 and use the remaining $300 as margin for a CFD on a stock listed on the NYSE.

(Please note that we have removed commission, spread and other fees from these calculations for simplicity).

The Advantages of Margin and Leverage

Margin and leverage are powerful tools that, if used with care and understanding, allow small investors to get massive returns on their investments.

Naturally, the prime draw is magnified profits. With leverage, investors take positions that are several times the value of their initial deposit. If the price moves in a favourable direction, the gain is equivalent to what they would have earned by investing the full amount.

Leveraged trading thus enables wider gearing. An investor who can allocate smaller amounts in individual leveraged trades gains the ability to trade more often and more widely than they would have otherwise.

The Disadvantages of Margin and Leverage

While the immense appeal of using leverage is its potential for magnifying profit, leveraged products come with certain perils, too.

A common side-effect of leverage is that the small initial deposit requirements give investors a psychological cocoon of safety. This tempts them to overinvest and exceed their liability thresholds.

Remember, price movements in the wrong direction will magnify losses. While your margin may be small, your exposure is the same as if you had invested the full amount. This can lead to a margin call, which occurs when your losses exceed a limit pre-set by your broker.

Payment is due promptly on a margin call and you may even have to pull money out of profitable investments to avoid defaulting.

Investors who have traded the share market will likely miss their shareholder privileges when trading leveraged products. In addition, dividends that otherwise benefit investors will work against you if you have taken a short position for a particular stock.

Always keep in mind that there may be fees and charges associated with leveraged products that you may not have encountered with other investments. Overnight holding charges, security deposits, larger bid-ask spreads and interest on the margin can diminish your profits.

Company Information: This website (www.ubrokers.com/eu) is operated by Capital Securities S.A., a Greek Investment Firm, authorized and regulated by the Hellenic Capital Market Commission (“HCMC”) with licence number 2/11/24.5.1994. The Company is registered in Greece under GEMI with register number 31387/06/Β/94/18. Capital Securities S.A. is registered at 58, Metropoleos Street, 105 63, Athens, Greece.

 

Capital Securities S.A. owns and operates the “Ubrokers” brand.

 

Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Between 74-89% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money. Past performance does not constitute a reliable indicator of future results. Future forecasts do not constitute a reliable indicator of future performance. Before deciding to trade, you should carefully consider your investment objectives, level of experience and risk tolerance. You should not deposit more than you are prepared to lose. Please ensure you fully understand the risk associated with the product envisaged and seek independent advice, if necessary. Ubrokers does not issue advice, recommendations or opinions in relation to acquiring, holding or disposing of any financial product. Capital Securities S.A. is not a financial adviser and all services are provided on an execution only basis. Please read our Risk Disclosure document.

 

Regional Restrictions: Capital Securities S.A. offers services within the European Economic Area (excluding Belgium) and Switzerland.

 

Capital Securities S.A. does not issue advice, recommendations or opinions in relation to acquiring, holding or disposing of any financial product. Capital Securities S.A. is not a financial adviser and all services are provided on an execution only basis.

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