Margin and leverage are terms that every trader gets to have a head-on encounter. The concept of leverage is quite simple though. But, there are several pitfalls that must be considered because they can affect the overall trader’s positions. This article will give you some very useful information about margin and leverage.
Is it wise to borrow funds from your broker?
As you all know, before you trade, you choose a MetaTrader platform and a broker that supports it. Then, they introduce to you the percentage of leverage that they can offer. So, what is really leverage? Leverage is the loan that a broker gives to its traders so they can easily increase their trading positions. But the term “loan” isn’t really the most suitable term for leverage. It’s because you don’t really get to hold the borrowed money or use it to purchase other things.
Leverage in Trading – How Does It Work?
As a borrowed fund, leverage appears to be like a bank loan. Nevertheless, these two work differently. Why? First, you don’t really own the loaned money, so you don’t have to personally pay the money back. Second, although you have raised your chances of profits, your risks have also increased significantly. So, why do brokers still offer leverage to traders if the risk of losses is also increased? How does your risk grow if you trade with leverage?
As you already know, leverage means higher risks. For the first question on why brokers offer leverage despite the risks it incurs, the answer would be; every broker profits for every position you open. Therefore, if you use leverage to open more positions, then they get to benefit from those opened positions, no matter the outcome.
When it comes to the risks involved when trading with leverage; you must understand that leverage is a two-bladed sword. For instance, you got $100,000 and earned $1,000. Your leverage here is 1:1, wherein the profit is 1%. But if you have a leverage of 1:100, your profit will also rise to 100%. Just by looking at these figures, you surely find it too appealing, right?
However, the situation could backfire on you if your situation turns sour, too. If your leverage is 1:1, you also lose $1,000 or -1%. But just like the example above, if you trade with a leverage of 100, you also get to lose 100% of your funds. That would blacken the image of the leverage now. Because of this, the leverage offered by brokers is mostly limited to protect their clients.
What Assets Can You Trade With Leverage?
As long as your broker permits and your MetaTrader platform is compatible, you can trade CFDs, currencies, and derivatives with leverage.
- Currencies – they are considered the most popular financial assets that do leverage trading. Almost every broker offers leverage when it comes to currency pairs.
- CFDs – they are quite famous among traders due to their attractive assets being offered.
- Derivatives – they are also highly used by traders. With leverage, traders can open larger positions which means larger profits too.