What is leverage? (2024)

Written by Katya Stead, Financial Writer. Reviewed by Axel Rudolph, Senior Market Analyst

Leverage is a key feature of trading and can be a powerful tool for you. Here’s a guide to making the most of leverage – including how it works, when it’s used and how to keep your risk in check.

What does leverage mean in trading?

Leverage in trading enables you to open a position worth much more than the money you deposit. For example, you might be able to multiply your position size by 5, 10, 20 or even 33x the amount of your initial outlay.

When trading, you’re speculating on the price movements of markets and underlying assets, rather than owning these assets outright, in the hope of making a profit. When you do this with leverage, it means that most of the capital is put up by your broker, with you putting down a deposit worth a fraction of the trade size in order to open a larger position.

Trading on stocks with leverage, for example, would mean opening a position with a broker and loaning most of the position’s value amount – depending on the leverage ratio – from that broker. There won’t be a charge for how much leverage you use – whether 5x or 20x your deposit amount.

So, for example, you may open a trade on Tesla stock worth £1000, with a deposit of £200. Your broker would put up the other £800 initially, enabling you to open a position 5x greater than your initial outlay.

What is leverage? (1)

How does leverage work?

Leverage works by using a deposit, known as margin, to provide you with increased exposure to an underlying asset.

Essentially, you’re putting down a fraction of the full value of your trade – and your provider is loaning you the rest. Although you’re only paying a small percentage of the full trade’s value upfront, your total profit or loss will be calculated on the full position size, not your margin amount.

Your total exposure compared to your margin is known as the leverage ratio.

Leveraged trading: an example

Let’s say you want to buy 1000 shares of a company at a share price of 100p. To open a conventional trade with a stockbroker, you’d be required to pay 1000 x 100p for an exposure of £1000 (not including any commission or other charges).

However, with leverage, you can pay a fraction of this cost upfront. If the margin amount was 20%, you’d pay just £200 to open a position worth £1000. Both your profits and losses would, however, be calculated on the full £1000.

If you went long on your trade and the company’s share price goes up by 40p, your 1000 shares are now worth 140p each. If you close your position, then you’d have made a £400 profit – double your initial margin amount of £200.

The reverse would be true if you went long and the share price dropped by 40p, you’d have made a £400 loss – double your initial amount paid. So, there’s substantial risk of profits or losses outweighing your margin amount.

What is leverage? (2)

How unleveraged trades work

When opening unleveraged positions, such as with share dealing, you’ll need to commit the full value of your position upfront. For example, let’s say you want to buy 10 shares of a company at a share price of 100p each. To open a conventional unleveraged trade, you’d be required to pay the full £1000 upfront.

This means more initial capital outlay, but it also caps your risk. That’s because, unlike leveraged trades, the risk of loss with unleveraged trading is equal to the amount paid to open the position.

So, in our previous example, the potential for loss is also limited to the £1000 you paid for the position. Although you’d only paid £200 to open a position of the same size with a leveraged trade, your profits can appreciate as much as the share price does, but you can only lose as much as you initially paid to open the trade – so £1000 at the most.

What is leverage? (3)

What leveraged products can you trade?

Most leveraged trading uses derivative products, meaning you trade an instrument that takes its value from the price of the underlying asset, rather than owning the asset itself.

The main leveraged products are:

What is leverage? (4)

Spread betting (UK and Ireland only)

A bet on the direction in which a market will move, which will earn more profit the more the market moves in your chosen direction – but more loss if it goes the other way.

What is leverage? (5)

Contracts for difference (CFDs)

An agreement with a provider (like us) to exchange the difference in price of a particular financial product between the time the position is opened and when it is closed.

There are lots of other leveraged products available with us, whether you have a spread betting or a CFD trading account. Though they work in different ways, all have the potential to increase profit as well as loss. These include:

  • Spot trading: open cash positions on the spot.
  • Futures: open longer-term contracts for a future date.
  • Options: buy contracts that give you the right, but not the obligation, to buy or sell an asset on a future date.

Which assets and markets can you trade using leverage?

Some of the markets you can trade using leverage are:

  • Shares
    With us, you can trade or invest in over 16,000 international and UK shares, from blue chips like Apple and Facebook, to penny stocks

  • Forex
    The world’s most-traded financial market – we offer over 80 currency pairs, from major to minor and even exotic pairs, 24 hours a day

  • Indices
    We offer over 80 indices around the world, with spreads from just one point

  • Commodities
    Trade 27 major commodities markets – including gold, oil, silver, natural gas and sugar – at their current market price with no fixed expiries

  • ETFs
    We offer over 5,400 ETF markets for you to gain broad exposure to speculate on indices, industries, sectors, currencies, commodities or baskets of stocks with one position.

What is leverage ratio?

Leverage ratio is a measurement of your trade’s total exposure compared to its margin requirement. Your leverage ratio will vary, depending on the market you’re trading, who you are trading it with, and the size of your position.

Using the example from earlier, a 10% margin would provide the same exposure as a £1000 investment with just £100 margin. This gives a leverage ratio of 10:1.

Often the more volatile or less liquid an underlying market, the lower the leverage on offer in order to protect your position from rapid price movements. On the other hand, extremely liquid markets, such as forex, can have particularly high leverage ratios.

Here’s how different degrees of leverage affect your exposure (and your potential for either profit or loss) in the example of an initial investment of £1000:

Unleveraged trading
1:1
Leveraged trading
20:1
Leveraged trading
50:1
Leveraged trading
100:1
Leveraged trading
200:1
Outlay£1000£1000£1000£1000£1000
Exposure£1000£20,000£50,000£100,000£200,000

When researching leveraged trading providers, you might come across higher leverage ratios – but be aware, using excessive leverage can have a negative impact on your positions.

Benefits and risks of using leverage

  • Magnified profits. You only have to put down a fraction of the value of your trade to receive the same profit as in a conventional trade. As profits are calculated using the full value of your position, margins can multiply your returns on successful trades – but also your losses on unsuccessful ones. See an example of magnified profit

  • Magnified losses. Margins magnify losses as well as profits, and because your initial outlay is comparatively smaller than conventional trades, it is easy to forget the amount of capital you’re placing at risk. You won’t be able to lose more than the balance on your account, but you should always consider your trade in terms of its full value and downside potential – and take steps to manage your risk

  • Gearing opportunities. Using leverage can free up capital that can be committed to other investments. The ability to increase the amount available for investment is known as gearing

  • Funding charges. When using leverage, you’re effectively being lent the money to open the full position at the cost of your deposit. If you want to keep your position open overnight you will be charged a small fee to cover the costs of doing so

  • Shorting the market. Using leveraged products to speculate on market movements enables you to benefit from markets that are falling, as well as those that are rising – this is known as going short, while share dealing means only making a potential profit on rising markets

  • No shareholder privileges. When trading with leverage, you give up the benefit of actually taking ownership of the asset. For instance, using leveraged products can have implications on dividend payments. Instead of receiving a dividend, the amount will usually be added or subtracted to your account, depending on whether your position is long or short

  • 24-hour dealing. Though trading hours vary from market to market, certain markets – including key indices and forex markets – are available to trade around the clock

  • Margin calls. If your position moves against you, your provider may ask you to put up additional funds in order to keep your trade open. This is known as margin call, and you’ll either need to add capital or exit positions to reduce your total exposure

Leverage and risk management

Leveraged trading can be risky as losses may exceed your initial outlay, but there are numerous risk-management tools that can be used to reduce your potential loss, including:

What is leverage? (6)

Stops

Attaching a stop to your position can restrict your losses if a price moves against you. However, markets move quickly and certain conditions may result in your stop not being triggered at the price you’ve set.

What is leverage? (7)

Guaranteed stops

These work in the same way as basic stops, but will always be filled at exactly the level you’ve set, even if gapping or slippage occurs. If your stop is triggered, there will be a small premium to pay in addition to normal transaction fees.

What is leverage? (8)

Negative balance protection

UK regulation ensures you cannot lose more than the equity available on your account. If your balance does go negative, we’ll bring it back up to zero at no cost to you.1
Using stops is a popular way to reduce the risk of leverage, but there are numerous other tools available – including price alerts and limit orders.


Remember, a crucial part of risk management includes always ensuring you have sufficient funds in your account. This is because your total profits to be paid to you or losses – to be paid by you – are calculated on your full position size, not your margin amount.

Let’s look at an example. Say you fund your account with £800. If you open a FTSE 100 position, which has a £500 margin, then your actual position size will be worth £10,000 (20x greater).

Even though you have £300 left in your account, any movement to your position is worth the full position size of £10,000. So, if the market moved against you by more than 2%, you would not have sufficient funds in your account to cover the losses and keep the position open.

This is why a key part of leveraged trading is having enough equity available in your account.

  • We reveal the top potential pitfall and how to avoid it
  • Learn from data gleaned from over 100,000 IG accounts
  • Discover how to stick to your plan and increase chances of success
What is leverage? (9)

Try these next

Take control of your trading using a range of risk management tools

Trade rising and falling markets by spread betting

Open a CFD account with us and access thousands of financial markets

What is leverage? (2024)

FAQs

What is leverage in simple terms? ›

Leverage or financial leverage is basically an investment where borrowed money or debt is used to maximise the returns of an investment, acquire additional assets or raise funds for the company.

What does it mean to have leverage? ›

If you have leverage, you hold the advantage in a situation or the stronger position in a contest, physical or otherwise.

What is leverage explained simply? ›

Key Takeaways. Leverage refers to using debt (borrowed funds) to amplify returns from an investment or project. Companies can use leverage to invest in growth strategies. Some investors use leverage to multiply their buying power in the market.

What is a leverage in finance? ›

Financial leverage is when you borrow money to make an investment that will hopefully lead to greater returns. It's built on the idea of spending money to make money. Examples of financial leverage can include: Buying a home, investing in a business and buying an investment property.

What is a good example of leverage? ›

Here's an example of how that would work. Let's say you have $100 of your own money, and you can borrow $1500 from the bank at an interest rate of 6%. You invest the entire $1600 in an investment, that you are confident will grow 15% in a year. You plan to return the borrowed money plus interest at the end of a year.

Why is leverage so powerful? ›

In essence, the power of leverage is all about taking advantage of existing opportunities and resources to move forward with your aspirations. The more strategic and creative you can be with your approach, the more success you'll have in achieving your goals.

Is leverage good or bad? ›

The use of debt, also known as leverage, can be a positive indicator of a company's health when future benefits are expected to compensate for the current debt. The problem is when debt becomes excessive and harms the funds needed to properly run a business.

What is another word for leverage? ›

On this page you'll find 17 synonyms, antonyms, and words related to leverages, such as: bargaining chip, weight, advantage, clout, pull, and grease.

What does the Bible mean by leverage? ›

Mark 4:20. Leverage in man's economy is debt owed to an individual or an institution with specific results required. Leverage in the Lord's economy is an obligation of faith and obedience to God's call with nothing but eternal upside.

What is leverage in life? ›

Leverage means, “the art of using something that you already possess to achieve something new and better.” ❯ Leverage helps you use your existing resources in a way to maximize results and achieve your dream outcome. ❯ The major types of leverage are time leverage, personal life leverage and skill leverage.

What is leverage in a relationship? ›

Leveraging relationships is not about taking for personal gain. It is about identifying how we can create value through the relationships we build. Too often, women hold back because we think we can only ask for a favor or a connection when we know we can reciprocate.

How do you leverage? ›

Leverage uses borrowed capital or debt to increase the potential return of an investment. In real estate, the most common way to leverage your investment is with your own money or through a mortgage. Leverage works to your advantage when real estate values rise, but it can also lead to losses if values decline.

What is leverage in simple words? ›

to use something that you already have in order to achieve something new or better: We can gain a market advantage by leveraging our network of partners. SMART Vocabulary: related words and phrases.

Is leverage just borrowing money? ›

Leverage refers to the use of borrowed funds or debt to amplify the potential returns or risks of an investment or financial transaction. It involves using borrowed capital to finance an investment or business activity with the aim of increasing the potential for higher returns on equity.

What is the risk of leverage? ›

Risk. While leverage magnifies profits when the returns from the asset more than offset the costs of borrowing, leverage may also magnify losses. A corporation that borrows too much money might face bankruptcy or default during a business downturn, while a less-leveraged corporation might survive.

What is leverage for beginners? ›

Leverage is a trading mechanism which can be used to increase the exposure to an asset class or financial instrument by allowing you to open larger positions than the actual capital you have placed into the trade position.

What is leverage in a short? ›

With IG, you can go short using leverage, which means you only need a small percentage of the trade value to open your position. If the underlying market price dips, you could make a profit. If the market price rises instead, you will make a loss.

What is an example of the word leverage? ›

I used the leverage of the bar and a wooden block to pry the rock out of the hole. The player's popularity has given him a great deal of leverage with the owners of the team.

References

Top Articles
Latest Posts
Article information

Author: The Hon. Margery Christiansen

Last Updated:

Views: 5844

Rating: 5 / 5 (70 voted)

Reviews: 93% of readers found this page helpful

Author information

Name: The Hon. Margery Christiansen

Birthday: 2000-07-07

Address: 5050 Breitenberg Knoll, New Robert, MI 45409

Phone: +2556892639372

Job: Investor Mining Engineer

Hobby: Sketching, Cosplaying, Glassblowing, Genealogy, Crocheting, Archery, Skateboarding

Introduction: My name is The Hon. Margery Christiansen, I am a bright, adorable, precious, inexpensive, gorgeous, comfortable, happy person who loves writing and wants to share my knowledge and understanding with you.