A lot of amateur traders nowadays are using cash to trade. For instance, they want to buy stocks worth $10,000. They need cash equivalent to the number of stocks that they want to buy which is $10,000. But professional traders use a different way to trade. They utilize leverage. With leverage, you can acquire $10,000 worth of stocks just by paying a minimum amount. Trading using leverage is very effective since it also improves your chance of profit since you have huge capital, without really paying the actual amount. It is more on a borrowed cash from the broker.
For instance, you trade in the futures market with a contract value amounting to $125,000. You won’t have to pay the whole amount. Through the use of leverage, you will only have to deposit a small amount, approximately $6,000. Leverage and margin are related to each other. Margin is the minimum deposit you need to be allowed to trade with leverage. In the amount mentioned above, the margin is $6,000 while the remaining $119,000 is called the leveraged amount or your loan to the broker.
Paying Attention to Leverage
A lot of traders are afraid to use leverage as they think that it is also the fastest way to lose money. This mindset is brought by all the warnings with regards to the use of leverage. These warnings aren’t to be taken lightly too since they are from brokerages and financial agencies who are knowledgeable enough in this industry like the U.S Securities and Exchange Commission (SEC). These warnings are the hard truth of leverage trading – that alongside its tempting benefits is the high degree of risk that a trader will have to embrace. If not handled properly, you may lose money more than what you have invested. For short, you will blow your account.
Scary things like this, make traders doubt the effectiveness of trading with leverage. However, at some point, these warnings might be misleading.
Leverage For An Efficient Use of Capital Investment
But because of fear, traders fail to recognize the real meaning of leveraged trading. The truth is, when you use leverage, you are actually using your capital efficiently. There are a lot of advantages of leverage and it overpowers the disadvantages. To trade with leverage means that you are allowed to trade in markets that are previously unavailable for you because you lack the funds or you cannot afford the cost. Trading on leverage doesn’t actually increase the trading risk. In fact, it is just the same as trading with cash.
The risk of leverage trading and trading with cash is the same. There’s no such thing as a reduced risk when trading cash or more risk when trading in leverage. Every trade you make is risky, that is why you need to employ a risk management plan and use stop loss and limit loss to minimize the loss, but not completely remove it. Moreover, losses and wins in trading are married to each other. You have to accept it and find a way to minimize its effects.