What is Leverage?

For anyone considering investing, it’s important to understand some key terms. Knowing these allows you to grasp how markets and trading work, so you can form strategies and make decisions that support your long-term goals.

Two important terms in this context are margin and leverage. “Margin” lets investors increase their buying power, which can help those with limited budgets. While it can enhance profits, it also comes with greater risk.

You may also wonder, “what does leverage mean in trading?” These terms are often used interchangeably. Both relate to opening a trading position with a broker using a small amount of capital to take a larger position.

With Trader Signal, understanding these concepts is essential before you start trading.

What is Leverage?

In simple terms, to leverage is to use something to your maximum advantage. In trading, it means taking the funds you have and using leverage to optimize your earning potential.

A simplified leverage definition: it’s a way to use a small amount of money to increase your exposure in the investment markets.

Example: Suppose you have £1,000 to trade and want to maximize potential returns. With Trader Signal offering leverage at 25:1, your £1,000 deposit could control a position worth up to £25,000.

What is Margin?

Although “leverage” and “margin” are often mentioned together, they have distinct meanings.

  • Margin is the amount of money required to open a position.
  • Leverage is the multiple of exposure that your margin allows.

How to calculate margin: divide the size of your intended position by the leverage ratio.

Example: To trade £25,000 with 25:1 leverage:

$$
\text{Margin} = \frac{£25,000}{25} = £1,000
$$

If leverage were 5:1, you’d need:

$$
\text{Margin} = \frac{£25,000}{5} = £5,000
$$

Formula:

$$
\text{Size of position} ÷ \text{Leverage ratio} = \text{Margin}
$$

The margin you deposit is known as the initial margin, and requirements vary based on the asset, market, and risk.

How Does Margin Relate to Leverage?

Margin is essentially a type of leverage using existing cash or securities as collateral, increasing your buying power.

However, it’s not unlimited. Taking on too much risk may trigger:

  • Margin Call: When your account balance plus unrealized profits and losses equal your margin requirement, the broker requires additional funds to meet minimum levels.
  • Stop-out: If your equity falls to half your required margin, open positions may automatically close to protect your account.

How Does Leveraging Work?

Leverage involves borrowing funds to increase potential returns. If your returns exceed the cost of borrowing, you can make a profit.

On Trader Signal via https://tradersignals.co.uk/, using leverage is optional. Different instruments offer various maximum leverage ratios, which must comply with legal limits.

Leverage multiplier: This amplifies your buying power. For example, a ratio of 10:1 means £1,000 deposited becomes £10,000 in trading power.

Example of leverage ratio calculation:

  • Small figure = your deposited capital
  • Large figure = amplified amount by broker
  • Ratio 10:1, deposit £1,000 → £10,000 trading power

Leveraged Buyouts and Stop Loss

Leverage in trading is similar to a leveraged buyout in business, where one company acquires another using borrowed money. With trading, you use borrowed funds to secure a larger position and maximize potential returns.