If you are like us, finance geeks, then you probably would have heard before of the term, “Leveraged Trading”.
Or maybe you read up about some terms that sound similar to it, such as “Contract For Differences (CFDs)”, “Forex trading” or “Indices trading”, and are curious to know what these terms mean, and how they are related to leverage trading.
In today’s article, we will explain the basics of what you need to know about leveraged trading.
What Is Leveraged Trading?
In the finance world, “leverage” refers to the use of borrowed capital to increase the exposure that an investor faces, in the hopes of earning a higher return than what an investor would be able to earn given the original capital put in. “Leverage Trading” refers to making trades in the financial markets using leverage. You put up an initial sum of capital, and that allows you to leverage to take up a much bigger position.
Types Of Leveraged Products
There are many different types of leveraged products. The most common product that people are familiar with is Foreign Exchange (Forex) trading.
Forex trading refers to the market in which currencies are traded. Currency trading works in pairs. For example, a trader can take up a position in the EUR/USD. They can decide whether the US Dollar will appreciate or depreciate against the Euro, and vice versa. They make money if they are right on the trade, and make losses if they are wrong.
Other common leverage products include Contract For Difference (CFD), Futures, Options and Binaries.
Different Leverage For Different Instruments
Since the risk involved in each instrument is different in its own ways, trading platform providers will provide different leverage for different instruments.
For example, IG provides leverage starting from 10:1 leverage for the purchase of stocks via CFD. For indices, this would be from 20:1, and for Forex, the leverage can go up to 50:1.
Managing Leverage In A Responsible Way
All financial products can be risky for investors and traders if the process of risk management is not taken seriously. Even trading treasury bonds, which the average investors would deem as safe, can be risky if a person is ignorant of the risks involved. The same can be said for leverage products.
Leverage is a double-edged sword. On one hand, traders need to utilise it to increase their exposure and profit on instruments that may otherwise not move by much. At the same time, the leverage could potentially translate into bigger losses as well.
A 1% movement in currency would just be a 1% loss of capital if no leverage were employed. With a 50:1 leverage however, that could result in a 50% loss on capital. Traders need to be familiar with the instruments they are trading, their current position and how much leverage they are employing.
Education – The Best Way To Be Informed of Your Risk Exposure
In our opinion, the best way to mitigate the risk for anything that you invest or trade in would be to get educated and to understand the various risks that you are exposed to.
When it comes to trading in leveraged products, the characteristics of the different instruments and asset classes are different from one another. Even among currency itself, different pairs would exhibit different characteristics, which is why you typically see good Forex traders only specialising in just a few currency pairs, with the EUR/USD being one of the most popular.
This use of risk management tools such as guaranteed stops can also help a trader protect profits and limit losses.
You can get yourself educated through the wealth of information readily available on the Internet. Some trading platform providers like IG also have different programs consisting of seminars and personalised walk-through that are catered to traders of different levels. The best part is that many of these seminars are free to attend, with the only hold back being your own appetite to learn and educate yourself.