when a trader invests in the financial markets, he mostly uses derivatives which benefit from leverage. Thanks to this leverage or leverage, the investor does not have to block all his capital to benefit from increases and decreases in the price of the underlying asset. To avoid disappointment, it is important to understand the leverage to choose the appropriate level before getting started.
What is Leverage?
Leverage makes it possible to multiply your exposure to a financial market by immobilizing only part of your capital. When making a leveraged investment, the amount needed to hold a position is called hedging. Trading with leverage is sometimes called margin trading.
Leverage exists for many financial products, including spreads, CFDs, and Forex. When you invest in a leveraged product, your broker will only ask you to immobilize a part of the total value of your position. In reality, the broker makes the remaining part available.
Gains and losses are calculated based on the total amount of your position. So the amount you win or lose may seem high compared to the locked-in amount. In a professional account, losses can notably exceed the initial deposit.
Example of Leverage
To give you a concrete example, imagine a 5: 1 leverage and a capital of 5000 dollars (called hedging as part of the leverage). If you want to buy Apple shares for $ 250, you can use a CFD and your investment will be the equivalent of $ 25,000 or 100 Apple shares.
If the price increases by 5%, your profit will be 1250 dollars or 25% of your initial investment whereas it would have been only 250 dollars without leverage. The reverse is also true in the event of a 5% decrease in the share price. You must also take into account the additional costs invoiced by the intermediary, but these are generally minimal in comparison with the potential gain that you get from using leverage.