What is Leverage?

Leverage is a way to amplify your buying power by borrowing funds from your broker. Brokers often offer leverage ratios like 1:5, 1:10, or 1:200. This means the broker multiplies your account balance by the given factor, increasing your buying power.

Example: Suppose you have $10,000 in your account and your broker offers a 1:10 leverage. This allows you to trade as if you had $100,000 in your account.

How Much Leverage Can I Get?

The amount of leverage offered varies by broker and is subject to regulatory limits. Generally:

• Leverage for cryptocurrency trading can be up to 1:10.
• For stock trading, leverage can be up to 1:20.
• For index/futures trading, leverage can be up to 1:200.
• For forex trading, leverage can reach up to 1:500 or even 1:1000.

CFD (Contract for Difference) brokers typically offer the highest leverage.

Difference Between Margin and Leverage

Margin is directly related to leverage. When you place a trade, the broker locks a portion of your balance as margin. For instance, if you buy 10 shares of a $200 stock, you would need $2,000 without leverage. With a 1:10 leverage, you only need $200, which will be locked as margin.

Margin is often expressed as a percentage. Here is a table showing the relationship between leverage and margin:

The lower the leverage, the higher the margin required for a transaction.

What is a Margin Call?

When your losses approach the margin level, you might receive a margin call. At this point, you have three options:

1. Deposit more funds to increase your available margin.
2. Close some positions to release margin for others.
3. Do nothing and hope for the best.

If you do nothing, the broker may start closing your positions.

Risk of Losing More Than Your Deposit

In extreme cases, such as when a broker cannot close your trades in time, you might experience losses exceeding your deposit. This is a real risk, especially with high leverage.

Scenario 1: Daily/Weekend Gaps

Gaps occur when the market reopens after being closed. The larger the closure period, the bigger the potential gap. High leverage during such gaps can lead to significant losses. For instance, stocks often have gaps on Mondays after the weekend, while cryptocurrency markets are open 24/7 and are less affected.

Scenario 2: Violent Market Moves/Crashes

A notable example is the EUR/CHF crash in 2015. The Swiss National Bank abandoned the EUR/CHF peg, causing a sudden 20% market collapse. Traders using high leverage faced severe negative balances.

Scenario 3: Circuit Breakers

Circuit breakers are used to restore order in markets when there is excessive movement in a short period. Trading is halted for 15 minutes, which can result in significant price gaps when trading resumes. This was evident during the COVID-19 crash.

How to Avoid Negative Balance Events

1. Stay informed about news releases, especially during market closures or weekends.
2. Reduce leverage during market crashes.
3. Minimize time exposed to the market. Higher leverage requires shorter trade durations.
4. Avoid leverage altogether: while the above measures can help, avoiding leverage entirely is the only guaranteed way to prevent negative balances.

Pros and Cons of Leveraged Trading

Pros:

• Allows you to profit from small market moves through day trading or scalping.
• Can accelerate account growth for consistently profitable traders.

Cons:

• Interest fees paid to brokers.
• Potential for larger losses.

If you are a day trader, leverage is essential. Although it introduces risks, it is crucial for making significant profits in day trading. The key is to manage risk and avoid over-leveraging.

Summary

Leverage is a tool that amplifies your trading capacity, while margin is the amount locked in your account for each trade. When losses approach the margin level, you may face a margin call.