Leverage - Stock Trader Glossary

Leverage is the use of borrowed capital (such as margin) to increase the potential return on an investment. In trading, leverage is often expressed as a ratio of the amount of capital that a trader can control with a given amount of margin. For example, a leverage ratio of 2:1 means that for every dollar of margin a trader puts up, they can control $2 of the underlying asset.

Leverage can be a powerful tool for traders, as it allows them to increase their potential profits without having to put up the full value of the underlying asset. However, it also amplifies the potential losses, since the trader is still responsible for paying back the borrowed capital even if the trade goes against them.

It's important to note that leverage is not always available or appropriate for all types of trading. Some assets or markets may have stricter margin requirements or may not allow margin trading at all. Additionally, using too much leverage can be risky and potentially lead to significant losses, so it's important to use it judiciously and with a clear understanding of the risks involved.

Moreover, the amount of leverage that a trader can use is often subject to certain limitations, such as margin requirements set by the broker or regulatory authorities. These margin requirements are designed to protect both the trader and the broker from excessive risk and potential losses. Traders may also use different levels of leverage for different types of assets or trades, depending on their risk tolerance and investment strategy. For example, a trader may use higher leverage for short-term trades or for assets that are more volatile, while using lower leverage for longer-term investments or for assets that are less volatile.

Ultimately, the decision to use leverage should be based on a careful assessment of the potential risks and rewards of the trade, as well as the trader's overall investment goals and risk tolerance. It's important to remember that while leverage can increase the potential profits of a trade, it also increases the potential losses, and should be used with caution and a clear understanding of the risks involved.

In summary, leverage is the use of borrowed capital to increase the potential return on an investment. While it can be a powerful tool for traders, it also amplifies the potential losses and should be used judiciously and with a clear understanding of the risks involved.