The leverage in online trading is using borrowed money to increase a net profit. 

When investors decide to use leverage, they borrow funds from a broker. A broker has a specified leverage ratio (eg. 1:10, 1:50, 1:100, etc) that investors can use for this purpose.  

Trading using leverage allows traders to trade markets that would otherwise be unavailable and allows them to trade more contracts (or shares, forex lots, etc). 

Using leverage carries the same risks on trades as when you don’t use it in relation to your initial investment. When trading with Limit Prime, because we protect our clients from a negative balance, you cannot lose more money than you deposited. Check here for more details regarding our policies.

Advantages & disadvantages of using leverage when trading

Leverage is a very efficient use of trading capital and is valued by professional traders precisely because it allows them to trade large positions in a stock without having to pay the full purchase price. 

If you trade with a broker that doesn’t protect you from negative balance, then you risk losing more money than you can afford, otherwise, this type of trading is no riskier than trading using cash.

So why should you use leverage when trading?

Advantage #1: Small deposits initiate possible high profits 

Leverage allows you to profit 20 to 100 (+) times more than your initial investment depending on the options your broker offers. 

For example, let’s assume that you have only 200€ to invest (deposit), but you would like to buy more than you can afford. To be able to buy an asset you desire that otherwise is unattainable for your current budget, you need to use leverage. If your broker allows you a leverage ratio of 1:100 with 200€ x 100, you will be able to trade with the amount of 20,000€, which by default also increases your potential profit. 

Advantage #2: Availability of many markets

With more capital in your account, more financial markets are available to you. Once you have a bigger amount of money ready for trading, more positions (on stocks, commodities, or indices) are at your disposal. And the more trading opportunities you have, the bigger your chances for profit.    

Advantage #3: You can trade more

If you have a small deposit on your account and you don’t use leverage, you can only trade with small lots. Remember the definition: Profit = Price x Quantity, and you will see that quantity is very important when trading. To acquire bigger lots in your trades, the leverage given by your broker comes in handy. 

Advantage #4: Leverage has no or very low interest

Our company offers you the use of leverage with no interest at all. This is very important for traders since it doesn’t increase the level of the total costs they have. Some brokers who charge interest on leverage are less appealing to investors. 

Advantage #5: Leverage is a legal use of capital

If your broker is licensed, then it has full legal support to offer you leverage. It is in the interest of a broker to give you this type of loan. Brokers want to see more trades and more active traders on their platforms. And the best way to have that is to lend traders’ money. 

Although the advantages of trading on leverage are numerous, it has some disadvantages that you should also consider.

What are the disadvantages of using leverage?

Disadvantage #1: Double-edged sword

As you have probably already heard, leverage is known to be a double-edged sword. You have the potential to make a profit and likewise, you also have the potential to lose money. Leverage increases your market exposure, thereby, increasing your risk. This is why you should be careful when choosing a broker and opt for the one that has an optimal leverage ratio and offers negative balance protection so that even in the eventuality that you are losing, you don’t remain in debt to them.

Disadvantage #2: Margin-call risk

A margin-call risk is when a brokerage firm informs a trader that they have fallen out of line with margin requirements. This means that if traders’ funds drop below a certain percentage of the margin requirements, brokers automatically close all of their opened positions and disable traders from opening new positions. As soon as this action is taken, you must add equity to your brokerage account. Failure to add equity after a margin call has been issued can result in the brokerage selling off your positions at will. 

Every broker defines and establishes a margin requirement and you should be able to find it easily. When trading with Limit Prime, a margin requirement is set at 20%.

Disadvantage #3: You are not the owner of an asset 

Leverage, as an opportunity, is available when you trade CFDs, which means when you are trading with prices of financial instruments, not the assets themselves. Therefore, when trading with leverage, you don’t have the benefit of taking ownership over shares or futures.

Example of using leverage

In the text below you can find an example of a trade with leverage on gold, and understand how your account is protected when you invest with Limit Prime

Limit Prime’s clients can use leverage up to 1:100. To simplify, let’s assume that you are our client, you deposited 1,000€ and want to open a position on gold. Leverage for gold is 1:100, therefore, you have 100,000€ (1,000€ x 100) available. Now, you are ready to invest in gold. Based on the charts and analysis provided, you see that the price of gold is rising and you predict that it will continue in that direction. Therefore, you decide to buy it (because later you can sell it at a higher price and earn a profit). Now, there are two scenarios possible. If you were right and the price of gold rose by 5%, you closed your position and earned a profit of 5,000€ (100,000€ x 0,05). But, in case you were wrong and the price of gold fell by 5%, you are only losing the money you deposited, which is 1,000€. This is called negative balance protection. Negative balance protection is applied regardless of the amount of the deposit. 

Conclusion 

Your trading strategy, or simply your trading capability is limited by the amount of money you have at your disposal. Brokers are here not only to provide you with a platform but also to help you increase your trading potential, by offering you leverage. 

That means you can operate with much more money than you have invested. Therefore, you can trade more and improve your trading skills; more financial instruments become available to you; you are on the road to higher profits and there’s no fee with using leverage. Trading with leverage offers great advantages but it has some downfalls as well. Be sure to understand them all before you make your choice.

 

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