What is leverage?

Leverage refers to using borrowed money as a source of investment to increase profits. Brokers offer leverages, and they let clients trade with a higher capital compared to their original account balance. They are considered an excellent tool for investors since they can multiply the profits in an investment. However, using the leverages can increase the investors’ potential loss if an investment does not work out properly.

How leverage works

Leverage is borrowed capital which is used to invest in an asset that can potentially magnify your profits. For example, you want to buy a house, but you don’t have enough money to do that. You go to a local bank and ask for a loan. In this situation, you are using leverage to buy an asset and expect an increase in the value of the house in the futures contract.

When investors decide to open a position and buy something, they have two options. They can either use only their own capital or a combination of their own capital and leverage to increase the size of their investment.

Different types of leverage

Leverage has different meanings in different sections of the economy. But in all of them, it refers to a debt that is used to reach a financial goal. There are three main types of leverages, and we are going to explain them here.

Leverage in business

Businesses can use leverages by taking out loans or issuing bonds. This method is suitable for new companies that don’t have many assets or companies that cannot sell their shares to raise money. They can use leverages for purposes such as buying materials and equipment or even expand their operations.

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But before using leverage, companies calculate the debt-to-income ratio to see if the risk or investment is worth making. If their returns turn out to be less than the borrowed money, they should ignore their plans to prevent losses.

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Leverage in investing

Using leverages by investors helps them increase their buying power. Some investors use the “buying on margin” to borrow money from a broker for their investments. But buying on margin is not always as easy as it seems. There are significant risks involved in this process. Sometimes investors lose more money than they initially had. That is why this strategy is only for experienced investors.

Leverage for personal finances

Although leverage is usually related to investments, some people use it to make big purchases. When people use leverage to purchase an asset and expect to see an increase in the value of that asset, they are using leverage—for example, taking a loan to buy properties, gold, or even starting a business.

Leverage ratio

The leverage ratios indicate how much a trade size can increase. For example, when you have 100$ in your account in a broker and use 1:100 leverage, you can use 10,000$ to make a trade. In other words, your initial capital is magnified 100 times. The brokers lend you this money and allow you to increase the size of your investment.

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Some brokers offer different leverage ratios from 1:2 to even 1:200. These leverages are not the same in the various brokers, and each broker may require specific margins requirements based on the assets which are being traded. Usually, brokers need traders to hold more money in their accounts for trading high volatility assets using leverages. This money acts as collateral. In a 1:100 ratio, the traders must have at least 1/100 of the total value of trade as collateral in their account.

Some may find using a 1:100 leverage very risky since you may lose a lot of money in a bad investment. However, these leverages are not offered for every asset. The big leverages are usually offered for less volatile assets, such as some currency pairs. You cannot lose much money if the price of an asset changes less than 1% on a trading day.

In order to use different services such as leverages in financial markets, you should find a reputable and experienced broker. DeltaFX provides you with the best services and significant leverages up to 1:1000. Open an account in forex right now to magnify your profit.

Conclusion

Leverage is a common strategy for investors, companies or individuals to use borrowed money for an investment and expect to profit in the future. Although it can increase the profit, you should be aware of the risks involved in using it. If you know what you are doing in a financial market, leverage can help you multiply your profit.

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