UNDERSTANDING LEVERAGE TRADING IN 2024: THE PROS AND CONS

WHAT IS LEVERAGE IN TRADING?

Before understanding the pros and cons, it’s better to know a bit about leverage. You have to grasp the notion of leverage as it is an important aspect of your trading. So let’s define this!

Think of leverage as a tool. A tool that can give you the power to trade more with less. But I’m not taking you to a mystical world This is what it is all about…You get borrowed capital when you open an account with a broker (such as SimpleFX).

Source: Yahoo Finance

Each broker has different leverage ratios. I’ll get to that in a minute. Through ratios, you can open a trading position.

Leverage in forex trading

Let’s give you an example. Say you want to buy 3,000 units of EUR/USD. To buy 3,000 units without leverage requires $3,000.

However, with leverage of 1:100, you only need $30. See, this is the magical world of leverage. It allows you to open much larger positions.

What are leverage ratios?

Let’s tell you more about leverage ratios. Every forex broker gives you an option of leverage. You can see a separate section on leverage on brokers’ websites.

The leverage you get from brokers depends on the regulations. For instance, the UK’s FCA doesn’t allow a leverage ratio over 1:30. Some brokers do offer astronomical ratios like 1:2,000 and 1:3,000.

With 1:3,000 leverage, if you have $5, you can set a position of $15,000 value. That’s the lure! It sort of draws you towards it to trade with less capital.

Source: Commodity Futures Trading Commission

But you should know that it is a lure with two edges. With leverage, you have both sides of the coin. What it means is it can make or break your trading. If it gives you the chance to gain, it can also prove risky.

You should understand that the greater the leverage, the more you are at risk. Let’s prove this point with a case of EUR/USD. Suppose you want to go long EUR/USD with 1:100 at 1.3700. You have placed a stop-loss at 1.3650.

Your balance is $1,000. You have picked a mini lot as a lot size. A mini lot equals 10,000 units or 1 in dollar value. You need a $137 margin.

You don’t need to calculate margin, as many brokers have a calculator for this. I’ll explain the margin in a moment. If the price moves in your favor by 100 pips, you make 1 x 100 = $100.

Let’s say the opposite happens; then you lose $100. So, you see how leverage acts. The greater your capital, the greater your risk.

Risks of forex leverage

I don’t like to use too much leverage. I normally use the leverage of 1:20 or 1:30. With these ratios, I can trade without risking too much.

HOW DOES LEVERAGE TRADING WORK?

A lot of people don’t get the hang of leveraged trading. They seem puzzled by the term. Well, it’s not like solving algebraic equations. Let me walk you through how it works.

Leveraged trading is about the funds you borrow from your broker. For example, brokers like Plus500 and FxPro provide you with funds, and you do the trading. It sort of magnifies your buying power. What you can trade with leverage isn’t possible without it.

Will leveraged trading earn you a cool $100 a day? Well, let’s not get our hopes high. Leveraged trading is not gambling. You have to apply risk-management strategies with it as well.

For instance, I never trade with more than 1 or 2 percent of my trading balance. As I explained above, leverage swings both ways. So, you have to take it easy.

HOW TO USE LEVERAGE IN DAY TRADING

Day trading and leverage seem like a perfect pair. You use leverage and make trades, and you gain at the end of the day. However, it isn’t as simple as it looks. Let me tell you why.

Day trading involves taking one or multiple positions in one day. When you use leverage, you sort of magnify your gains and losses. But here’s the deal: use a lower leverage ratio in day trading. Why?

Because in day trading, you never know what’s going to happen. You see a trend going in your direction, and suddenly, it goes the other way. You have to be smart about this.

When day trading, use minimum leverage like 1:30 or 50. Along with this, keep your risk per trade at 1 percent or 2 percent of your bank. This way, even if you lose on your day trades, you are not gonna lose big.

WHAT IS MARGIN TRADING LEVERAGE?

Leverage and margin go hand in hand. According to a Yahoo survey, 23 percent of accounts in US stocks are using margin. When talking about leverage, you need to grasp margin also.

Brokers don’t give you leverage from the goodness of their hearts. They need some insurance or security. To control a $5,000 or $10,000 position, your broker will set aside specific funds.

If you have 1:100, you have a $1,000 buying power with $10. The $10 amount you must have in balance acts as a margin. It’s sort of a good-faith deposit that your broker requires.

Forex margin

You must have some margin in your account if you want to leverage. Brokers with high leverage, such as 1:1,000, have lower specs. For instance, in our previous example of 1:100, the margin was 1 percent.

It means your account balance’s 1 percent. For instance, if you have a $5,000 account, the margin is $50.

HOW TO TRADE ON LEVERAGE: Pros

I mentioned how leverage is an advantage if you apply it carefully. Let’s explain some of its pros.

You only need a small amount

With leverage, you have more trading power. You only need to invest a fraction of equity with leveraged trading. With more leverage, you require less account equity.

Tool against low market moves

Market volatility is super significant! Sometimes the market can go crazy, but other times it lies low. So, in a situation where it lies low, you need leverage for profits. When there is low volatility, leverage multiplies your profits.

Leverage brings more

You know the forex market spins around 24/7. It’s an owl that never takes a breather. It runs from Monday to Friday, 24/5.

Using any leverage, you can take advantage of it. You can open positions multiple times during the week. By doing this, you can gain more.

Short and long

For forex, you can buy or sell a pair. You just have to know the trend’s direction and enter a position. Leverage plays a part in either scenario. You go long or short; you can gain either way.

IQ Cent doesn’t mention anything about leverage on its website. However, you can go long and short with leverage trading.

Quick returns in a short period

It gives the option of making quick bucks in a short period. By using higher ratios like 1:1000 or above, you can take advantage of the market moves. Plus, if you apply risk management with high leverage, it’s the cherry on top.

HOW TO TRADE ON LEVERAGE: CONS

With advantages come pitfalls. As I said earlier, leverage works both ways. It can make or break your trading. Let’s discuss the pitfalls!

 Multiplies losses during high volatility

When there’s a high market move, using high leverage can backfire. During high volatility, forex pairs can make wild movements. You don’t know where the trend is heading. A high figure like 1:2,000 can eat up all your accounts in this scenario.

The danger of a margin calls

You need some balance in your account for trading. That’s how your broker offers you leverage. When your balance goes low, your broker needs more margin.

So, that you can keep your positions open. If you don’t deposit more, you can get a margin call. A signal of a margin call suggests your balance is zero. That’s why using low leverage avoids calls.

WHAT ARE SOME PRO TIPS FOR LEVERAGED TRADING?

So far, you have learned about leverage and its pros/cons. Here are some pro tips on using leverage. So let’s jump right in!

A large ratio doesn’t mean you have to use it. Although it gives you more buying power, remember it works both ways. You have to use leverage according to your trading plan.

There’s a reason 43 percent of retail investors are trading with leverage. If you want consistency, you have to keep the leverage ratio low. You have to use it in a way that keeps your trading manageable.

Don’t go for scalping or intra-day trading when it comes to leverage. It’s tempting to apply a high ratio for scalping for quick bucks. However, the risks are not worth it. You can end up blowing your account.

There is no perfect leverage ratio. I would suggest not using more leverage than the 1:20 ratio mentioned earlier. If you must try greater leverage, do it on an account funded with just a small part of your bank. So, even if you blow the account, you don’t lose too much.

HOW TO TRADE LEVERAGED ETFS

Trading with leveraged ETFs seems like a fun idea. According to stats, there is $7.74 trillion worth of ETFs managed globally. So, how can you trade leveraged ETFs? Well, let’s find out.

A leveraged ETF allows you to hold assets like forex pairs. When they go up, your leveraged ETFs go up. ETFs are like a basket of assets.

You buy them like a forex pair. ETFs contain these assets from the index like the good ol’ S&P 500. When the sector goes up, you’ll profit from it.

Leveraged ETF chart

Using leverage with ETFs is like any other asset. You select your leverage ratio, and voila! So, about those $7.74 trillion worth of ETFs managed globally.

Can you take a piece of the pie? Of course, you can! You just have to apply risk management, and you are good to go.

CAN LEVERAGED EXCHANGE-TRADED FUNDS BE A LONG-TERM INVESTMENT?

The thought of leveraged ETFs as long-term investments tickles our brains. TBH, if I’m trading with leverage, it doesn’t mean I can’t go long-term.

You just have to make sure you know what you are doing. Let’s see how you can trade leveraged ETFs for the long term.

Like your usual long-term investments, ETFs can bag you big bucks. If only you follow the basic trading plan and apply risk management. See, leveraged ETFs are a bit puzzling, so you have to make sure you use the right leverage.

Chart showing holding of leveraged ETFs for long term

Should I use higher leverage like 1:100, so I can bag some cool bucks? If you use a hefty leverage ratio like 1:1,000, then it’s super risky. And you won’t hold it for the long term.

Plus, a gentle reminder that leveraged ETFs cost you more than non-leveraged ones. So, if you are going for long-term investments, consider this point.