everage 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?
The meaning of leverage in finance is to make a trade or investment with borrowed funds as your main capital outlay. So, financial leverage is the act of borrowing a sum to trade on or invest in an asset or market in the hopes of making a profit.
When trading leveraged stocks, for example, this 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. So, you may open a leveraged trade on Tesla stocks worth £1000 with £200 with us at a leverage ratio of 20%, borrowing the other £800 from us.
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.
For 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 (ignoring any commission or other charges).
If the company’s share price goes up by 20p, your 1000 shares are now worth 120p each. If you close your position, then you’d have made a £200 profit from your original £1000.
Unleveraged vs leveraged trading:
Unleveraged trades are the opposite. With unleveraged products, such as share dealing, you will 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 this full value upfront (£1000).
This means more initial capital outlay but also caps your risk more than leveraged trading, as 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, unlike the £200 paid for a leveraged trade
Leverage
If the market had gone the other way and shares of the company had fallen by 20p, you would have lost £200, or a fifth of what you paid for the shares.
Or you could have opened your trade with a leveraged provider, who might have a margin requirement of 10% on the same shares.
Here, you’d only have to pay 10% of your £1000 exposure, or £100, to open the position. If the company’s share price rises to 120p, you’d still make the same profit of £200, but at a considerably reduced cost.
If the shares had fallen by 20p then you would have lost £200, which is twice your initial deposit.
What leveraged products can you trade?
The majority of 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:
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.
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 ways to trade these leveraged products with us. 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 markets can you trade using leverage?
Some of the markets you can trade using leverage are:
- 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 - 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. - Indices
We offer over 80 indices around the world, with spreads from just 1 point - Commodities
Choose from over 35 commodities when you trade with us, including gold, oil and silver.
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 | Leveraged trading | ||||
| 1:1 | 20:1 | 50:1 | 100:1 | 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, trading on margin can multiply your returns on successful trades – but also your losses on unsuccessful ones
- Magnified losses. Leverage magnifies 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