How to trade with leverage?

What is leverage, and how does it work?

Leverage is a tool that allows you to increase the size of your trading positions by using borrowed funds from the broker. Essentially, it's the ratio between the amount you invest from your funds and the total transaction amount.

Let's look at how leverage works in CFD trading.

• Determining the size of leverage: Leverage is usually expressed in ratios, such as 1:10, 1:20, 1:30, and so on. This ratio determines how many times you can multiply your initial capital to open a position. For example, a 1:20 leverage allows you to open a position 20 times greater than the initial deposit.
• Opening a Position: You want to invest in company shares using CFDs and apply leverage. If the shares cost €100 each and you want to buy 1 lot (100 shares), you would typically need 100 × 100 = €10,000. However, with 1:20 leverage, you only need to deposit 1/20 of this amount, which is €500.
• Profits and Losses: When calculating profits or losses, you must consider the total transaction amount, not just the sum you invested. If the share price rises by €10, your profit would be €1,000 (100 shares × €10). This is 20 times more than if you had solely relied on your funds. Conversely, a €10 decrease in share price would lead to a €1,000 loss, potentially surpassing your initial deposit.

How to calculate leverage and margin

Technical analysis is the most widely used method for evaluating the performance of a trading instrument or asset. By studying patterns and trends of the price, technical analysis helps predict its future movements and identify a setup for a profitable trade.

Technical analysis is a vast subject, covering numerous topics with many analytical methods, tools, and techniques. In this article, we primarily focus on three most basic concepts:

• Trends
• Support and resistance levels
• Candlestick patterns

How to find support and resistance levels?

Prices don't move in a linear fashion. Trends often pause near specific obstacles, called support and resistance levels.

• A support level: It is a price level at which a trading instrument tends to stop falling and may even rebound or rise upwards.
• A resistance level: It is a price level at which a trading instrument tends to stop rising and may even pull back or fall downwards.

Identifying support and resistance levels will help you identify potential entry and exit points. They are commonly known as stop-loss and take-profit levels.

Static or horizontal support and resistance levels are found near round numbers or where a lot of buying and selling activities took place in the past. However, support and resistance levels can also be dynamic and change over time as market conditions evolve. For example, a bullish trendline you saw on the chart above can act as a kind of dynamic support, while a bearish trendline acts as a resistance. Notice that once the trendline gets broken, the opposite trend usually follows.

How to calculate leverage and margin

Leverage and margin are close terms in trading. Here's how you can calculate them.

Leverage is typically expressed as '1:x', where 'x' shows how many times your available trading funds can be increased. For example, a 1:50 leverage means you can use each euro of your capital to open positions up to €50.

Leverage (L) is calculated as the reciprocal of the margin (M):

L = 1/M

For instance, if the margin is 5% (0.05 in decimal), then the leverage would be:

L = 1/0.05 = 20

Thus, the leverage would be 1:20.

Margin is the amount of funds you need to open and maintain positions. It is usually expressed as a percentage of the total value of the open position.

Margin (M) is calculated as the reciprocal of leverage (L):

M = 1/L

You can calculate the margin in monetary terms. For example, if you want to open a position of €10,000 with a leverage of 1:100, your margin would be:

M = (1/100) × 10,000 = €100.

This calculation means you must have at least €100 in your account to open such a position.

A 1:20 leverage means you can borrow from the broker for a transaction, an amount 20 times greater than your funds. For instance, to open a €20,000 position with 1:20 leverage, you need to deposit only €1,000 of your funds. The broker provides the rest as borrowed funds. Be careful, as this ratio can increase both potential profits and losses.

At Actually, you can use a Trading calculator and Profit calculator instruments to determine your strategy in the market. Try leverage trading with our free demo account first to meet with the tool and boost your knowledge.

Advantages and disadvantages of leverage trading

Leverage trading allows you to meet several opportunities.

• It increases potential profits if the market moves favourably.
• It frees up your capital to use for other trades.
• It allows you to trade with financial instruments that might be unaffordable without leverage, enabling a broader diversification.

There are also disadvantages that you should keep in mind:

• Leverage trading amplifies risks – as potential profits increase, so do potential losses.
• It requires careful risk management and a solid strategy.
• It may lead to opening a position that is too large relative to your funds, potentially resulting in significant losses.

What is a margin call and stop out?

Margin trading, also known as leverage trading, allows you to conduct transactions with securities and currency even if you don't have enough funds to purchase or sell the necessary assets. In simple terms, margin trading is trading with borrowed funds provided by the broker. This form of trading amplifies both potential gains and losses.

After executing a trade, you must monitor your open positions. If the value of your portfolio falls below the broker's required level, a margin call will occur. It happens when the margin reaches or falls below 100%. Immediately after this you will receive a notification request to deposit more funds to maintain open positions.

If you choose not to add funds, the equity in the account may continue to drop. After it reaches a critical low point below 50%, the stop-out happens—broker automatically closes some or all of your positions to limit further losses.

Both mechanisms are safety features that protect both the trader and the broker from excessive losses in a highly leveraged environment. After positions are closed, losses  will be subtracted from your account balance. If you're unable to add funds after a margin call, the broker will inevitably force the closure of your positions.

Conclusion

Leverage is an essential tool for investors that can help open new trading strategies and opportunities. However, leverage trading is risky, especially for beginners. So sometimes, newbies in trading opt for more straightforward instruments without leverage. Risk management is crucial to minimize losses and maintain investment stability. You can learn more about risk management in our educational article.