In the financial market, leverage refers to borrowing funds from brokers/dealers to create positions and trade more than the principal investment . In this way, investors will have greater flexibility and obtain higher returns when trading with less capital. This article will introduce examples and operation methods of leveraged investment.

What is leverage?

Leverage is expressed as a multiple or ratio. Assuming the leverage ratio is 1:100, the total investment value is 100 times the trader's principal (in CFD trading , the leverage ratio can be as high as 1:2000). Although the investor's principal (i.e. margin) is only part of the total transaction value, the profit or loss of the transaction will still be calculated based on the total transaction value, so the profit or loss ratio will be magnified.

Here is an example of how leverage can affect potential gains or losses:

• If you have $1,000 in principal and buy $1,000 worth of assets without leverage, you can make a profit of $10 for every 1% increase in the price of the asset you invested in. On the contrary, if it falls, you will lose $10, which is equivalent to 1% of the principal of $1,000.
• But if you also invest $1,000 and use 10x leverage, you can buy assets worth $ 10,000 . So if the price of the asset rises by 1%, you will make a profit of $100, otherwise you will lose $100.

Leveraged funds multiply your trading results. As can be seen from the example, 10 times leverage will magnify the potential profit or loss to (initial funds of $1,000 / $100) = 10%.

The relationship between margin and leverage investment

A deposit refers to funds paid in advance to guarantee the fulfillment of a certain obligation, and its essence is a credit deposit.

In leveraged trading, margin is the capital invested by investors, which is essentially the funds paid to banks, brokers or counterparties for opening and maintaining positions. The ratio of margin to the total amount of trading contract products is the margin ratio, which can also be called the leverage multiple or ratio.

Margin ratio = 1/ leverage ratio

If the margin ratio is 0.2%, it means the leverage ratio is (1 / 0.2%) = 500 times

Investor's capital (margin) = total transaction value / leverage ratio

If an investor wishes to trade a contract with a total value of USD 10,000 at 500x leverage, he or she will need to invest at least USD 20 as margin to open a position ($20 = $10,000 / 500x).

20 USD is the initial margin for opening a position. The general trading rules also include a minimum margin ratio (also known as forced liquidation ratio)  , such as 20% or 30%. This is to ensure that the margin invested by investors can be maintained at a certain level to offset the potential losses caused by holding the contract.

Take a foreign exchange margin trading example. When the EUR/USD exchange rate is 1.14, an investor buys 1 lot of a standard contract of 100,000 euros. When the leverage ratio is 1:400, the margin required to be paid is: ($1.14 x 1 x 100,000 / 400) = about 285 US dollars.

Margin = opening price x trading lots x contract unit / leverage multiple

If the minimum margin ratio of this contract is 30%, when the floating loss on the contract causes the net value of the account to be less than US$85.5, the dealer has the right to force liquidation of the Euro contract. The concept is that the investor may not have enough funds to maintain and fulfill the contract. It should be noted that the calculation method of the margin ratio and the execution of forced liquidation must also follow the requirements and guidelines of different dealers.

As can be seen from the formula, margin and leverage are inversely proportional. The larger the leverage ratio, the less margin is required, and vice versa. However, even if the leverage ratio is larger, it does not mean that investors will only invest less initial margin. In fact, they will also invest more margin according to actual needs to ensure that the contract will not be easily forced to leave.

Analysis of the advantages and disadvantages of leveraged investment

The most obvious advantage of leveraged trading is that it can bring greater profits to investors. Investors only need to invest part of the margin and use relatively little cost to flexibly and conveniently capture investment opportunities in the market.

However, when the position held moves in an unfavorable direction, the investor's losses will be magnified just as the gains will be magnified. Under leverage, the losses will be multiplied. If leverage is not used properly and proper risk management is not adopted, this will bring some additional risks to investors.

The concepts of leveraged trading or margin trading are the same. Not only do they have low threshold requirements, they also have the characteristics of two-way trading, amplification, and interest rate return. The so-called "small investment for big returns" has attracted a large number of investors to participate in such transactions.

Investors who choose to use leveraged trading should understand the risks involved, exercise self-discipline to control the extent of use, and develop appropriate strategies to avoid incurring unnecessary serious losses.

When trading with leverage, please pay attention to risk management

• Stop loss: Stop loss can be used to close a position at a pre-set price when the market moves against you, limiting your losses. You can set it based on the market price, a specific fluctuation range, or a specific amount.
• Take Profit: Take Profit allows you to automatically close your position and make a profit when the set target price is reached. This avoids missing out on ideal opportunities due to being too busy or resting to handle positions.

Negative Balance Protection: In rare cases, if your account equity becomes negative due to market conditions, some dealers/brokers may cover your losses and reset your account equity to zero.

Leverage trading is a double-edged sword that can double your profits or losses. The right investment mentality is very important and risk management tools must be used.