What is leverage and what is leverage benefits and how to apply for trading.

 What is leverage and what is leverage benefits and how to apply for trading.

What is leverage?

Leverage is a ratio between the amount of collateral and the volume of trading operations. To make it easy to understand we will share with you a simple definition : Leverage is the ability to control or manage a large amount of money by borrowing some of your own money and the rest. In financial parlance, this is called Other People's Money (OPM).

Example : A good example of leverage is when an investor borrows money to invest in stocks. Let's say Tesla stock price is trading at $100 and you have $10,000 with no leverage. You can buy a maximum of 100 shares.

However, if you go to a bank and take out another $10,000 and use it to buy stock, you can now afford to buy 200 shares. When the stock doubles, your total profit will be $40,000. After paying back the funds borrowed from the bank, your profit will be $20,000 minus the bank interest.

How to leverage work's

When leverage works, it is very useful for traders and investors but if it fails, the losses can exceed the initial capital of the investor resulting in a negative balance. In the above example, if the stock falls to zero, the investor will first have a personal loss of $10,000. They will then need another $10,000 to pay back the bank.

Leverage in the Forex trading

In the Forex and CFD industry, the concept of leverage works in a similar way to borrowing to buy a stock. Online brokers offer virtual credit to their customers known as leverage. This virtual credit is usually backed by a deposit of the customer. This enables them to trade in more financial assets.

It is impossible to separate the concept of leverage from margin in trading. Margin is the amount of money a trader must have in order to use leverage. It's just a deposit required by good faith brokers so they can extend credit to traders. Margin is expressed in percentage. If the broker requires 2% margin, you have 1:5 leverage and if they require 0.25% margin, you have 400:1 leverage.

For example, if a trader has $1,000 in his account and uses a leverage ratio of 1:5, that means the trader can buy $5,000 worth of assets. If a trader's leverage is 100:1, it means he can buy $100,000 worth of assets.

The amount of leverage offered by brokers depends on regulatory guidance. In the European Union, for example, directives raise this leverage to 30:1. In the US, the Financial Industry Regulatory Authority (FINRA) requires that brokers can only offer leverage to those with at least $2000 in their accounts.

Advantages of leverage

Using leverage can be beneficial in three ways. First, it helps the trader to maximize profit in each trade, as you will see in the example below. Second, a leveraged trader with limited resources can trade in expensive assets such as bitcoin, gold, and platinum, while without leverage, it would not be feasible for a trader with $1000 in his account to trade in gold. Which is currently trading at $1,200.

The size of leverage a trader uses is very important in determining success. When the trade goes right, a high-leverage trader can make more money than a low-leverage trader.

When you are trading, you will trade with lots. A standard lot is equal to 100,000 units of base currency, but it doesn't mean you should have to spend that much yourself. Your broker can help you. Standard leverage is 1:100. This means that if you want to trade a standard lot of the pair, you only need to make a deposit of 1,000. Your broker will invest the remaining $99,000.

For example, you have $1000 in your account, and you decide to sell the USD/JPY instrument which is trading at 110 price. Your account has a leverage of 50% and the broker requires a 1% margin deposit. Also, assume that the standard lot price is $5. For the 5 tandard lot sizes, the price is $25.

In this trade, you will sell USDJPY short for $50,000. Using the above assumptions, if the price of the USD/JPY pair goes down by 100 pips, your profit will be $2500.(100 pips x 25)

On the other hand, if you decided to use a leverage of 10, you would have a total trading capital of $10,000. If you get 100 pips, your total profit will be 250$.

In the next article we will discuess on how to mange the risk in the leverage. stay tuned with us. Bye have a nice day.