Have you ever traded the markets? If so, then you know that leverage is a powerful tool that can help you make big profits – or big losses. Unfortunately, many new traders ignore leverage completely, which is one of the main reasons why most of them fail. In this blog post, we’ll show you why leverage is so important in trading, and how you can use it to your advantage.
What is leverage and why is it so important in trading?
We talked a bit about leverage and its relationship with margin earlier, but it’s worth revisiting. Leverage is a powerful tool that is used often in trading. It is essentially the ability to control and manage large amounts of money with only a small amount of capital, allowing traders to maximize their potential profits — or losses. By investing on margin, traders can increase their exposure relative to the amount of money they have invested, meaning they can make larger returns even with smaller amounts of money.
Leverage is a double-edged sword though and it can magnify losses just as easily as profits, so it’s important for traders to use it carefully. Understanding how leverage works and how it can be used effectively is an essential part of successful trading.
Why do most new traders ignore leverage and end up losing money?
Leverage can drastically amplify both gains and losses in the trading markets, so naturally, it can be a difficult concept for new traders to come to terms with. Unfortunately, many inexperienced traders remain unclear about what leverage is, or simply ignore its implications altogether, risking their hard-earned money. When these traders overestimate their understanding of leverage, they often become overconfident and take on too much risk. As a result, they suffer heavy losses due to overexposure; leverage comes with a tremendous amount of risk that further worsens the impacts of bad trades.
The majority of pro traders take positions of one standard lot for every $50K in their account — or one mini lot for every $5K. So, why do new traders think they can prosper by trading huge leveraged sums? The reality is that most new traders fail because they are undercapitalized and overleveraged — or worse, don’t understand the impact of leverage.
In terms of undercapitalization, experts recommend that you meet the following thresholds to open an account and avoid the allure of overleveraging:
- $100,000 of trading capital for a standard account
- $10,000 for a mini account
- $1,000 for a micro account
Of course, an alternative funding mechanism exists with prop firms like SurgeTrader — firms that will fund your trading activity so that you don’t have to come up with large sums on your own.
Ultimately, most new traders open a trading account with just the minimum deposit, but they often don’t understand the implications of leveraging and margin.
What are some of the risks associated with using leverage in trading?
When it comes to trading in the markets, leverage is a powerful tool that has allowed many traders to amplify their returns. However, leverage also introduces extra risk; if trades move against the trader, they can suffer large losses in a very short timeframe. The most common risks when using leverage while trading includes the following:
- Greater market volatility leads to wider spreads in prices.
- Rapid shifts in price movement result in aggressive losses when specific instruments are traded.
- With higher margin requirements imposed by brokers, traders can find themselves overextended and unable to meet their margin call obligations
While leverage can lead to higher profits and increased purchasing power when managed properly, traders should be aware of these potential risks before deciding to use it.
By taking advantage of leverage, traders can increase their buying power and gain more control over profitability and loss patterns. Properly managed positions using leverage can result in larger gains than those achieved without it. However, traders must not forget to always exercise caution and utilize proper risk management when leveraging, as there are always risks associated with trading on margin.
Disclaimer: All information provided here is intended solely for study purposes related to trading financial markets and does not serve in any way as a specific investment recommendation, business recommendation, investment opportunity, analysis, or similar general recommendation regarding the trading of investment instruments. The content, in its entirety or parts, is the sole opinion of SurgeTrader and is intended for educational purposes only. The historical results and/or track record does not imply that the same progress is replicable and does not guarantee profits or future profitable trading records or any promises whatsoever. Trading in financial markets is a high-risk activity and it is advised not to risk more than one can afford to lose.