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Leverage allows traders to gain full market exposure with a relatively small initial investment. In this guide, we’ll delve into how leverage works, its benefits, and the associated risks.

What is Leverage in Trading?

Leverage in trading refers to using borrowed funds to amplify your potential returns. By putting down a small deposit, you can open a position that represents a larger amount of capital. This means that while the potential for higher profits is increased, so is the potential for significant losses.

Key Insight: Leverage can magnify both gains and losses, making it crucial to understand and manage the risks effectively.

What is Margin in Trading?

Margin is the amount of money you need to deposit to open and maintain a leveraged position. It’s expressed as a percentage of the total position size. This initial deposit acts as collateral for the borrowed funds used in the trade.

Once a position is opened, you must keep sufficient funds in your account to cover the margin requirement. This requirement varies depending on the market conditions and the size of your position.

Pro Tip: At City Index, the margin requirement is automatically calculated for you. Simply enter your trade size to see the required margin. Check out the City Index demo to see this feature in action.

Example of a Leveraged Trade

Imagine you want to buy 10 Apple shares, each priced at $175. Without leverage, you’d need to pay the full $1,750 (excluding fees). If the share price rises by $5, your profit would be $50 (5 x 10), but if it falls by $5, your loss would be $50.

With Leverage: Suppose you use leverage and only need to put down 20% of the $1,750. This means you’d deposit $350 to control $1,750 worth of shares.

Your profit and loss are still based on the full position size. If the shares increase by $5, you make $50, and if they drop by $5, you lose $50.

Types of Leveraged Products

Several types of leveraged instruments can be used in trading, including:

Contracts for Difference (CFDs): Allow you to speculate on price movements without owning the underlying asset.

Spread Bets: Enable you to bet on price changes without actually buying or selling the underlying asset.

Futures Contracts: Agreements to buy or sell an asset at a future date for a predetermined price.

Options Contracts: Provide the right, but not the obligation, to buy or sell an asset at a specific price before a certain date.

We’ll explore these instruments in more detail in the upcoming sections.

Risks of Leveraged Trading

While leverage can enhance potential profits, it also increases risk. Here are key risks to consider:

Magnified Losses: Since your profit and loss are calculated based on the total position size, you could lose more than your initial deposit if the market moves against you.

Margin Call: If the value of your position declines and your margin level drops, you might receive a margin call. This occurs when you need to either close your position, reduce the size of your trade, or deposit additional funds to cover losses. If your margin level falls below 50%, your position may be automatically closed.

Margin Level Indicator: To help manage your margin, City Index offers a Margin Level Indicator on your trading platform. It shows:

Sufficient Margin: If your indicator is above 200%, you have enough funds to keep your positions open.

At Risk: If it falls between 80% and 200%, you’re at risk of a margin call.

Insufficient Margin: Below 80%, and especially under 50%, indicates insufficient funds, putting your positions at risk of closure.

Funding Charges 

Trading on leverage involves borrowing money from your provider, which typically incurs a small fee. This is akin to paying interest on a loan. We’ll delve deeper into funding charges and overnight costs in Lesson Six.

Understanding leverage is crucial for managing both potential rewards and risks in trading. With careful consideration and effective risk management, you can use leverage to enhance your trading strategy.