Leverage
Leverage is
an investments technique used by
investors to increase the profitability of their investments. Leverage
involves
using financial debt to boost the initial deposited used to trade
financial
instruments.
To understand how leverage works, let's assume that you want to trade an asset X and your broker offers you leverage of 1:100. This means that your broker is willing to lend you $100 for every $1 you will invest, and assuming that instruments X is of the value of $1, instead of buying 1 share you will be able to buy 101 shares for the price of $1.
Now
if
stock X moved up to the value of $2 per share, you have made a profit
of $202
instead of $1. However, if X dropped to $0.5 per share, you have a loss
of
$50.5 instead of $0.5.
In other
words, leverage is a great power
that can work with or against the trader depending on how good the
trade is. It
is simply a way to increase both profit and risk. Leverage can be
created
through options, futures, margin and other financial instruments. When
it comes
to using leverage, we recommend matching the leverage to the level of
certainty/uncertainty of the trade and keeping the size of the trade
reasonable.