Do you want to get into the world of stock trading and have big positive results? (Who wouldn’t, right?) Well, if you have ever thought about borrowing money to invest and get a greater return, you were using principles of leverage trading for beginners. It sounds complex and confusing, but actually, it is very quick and easy to understand.
Leverage trading can help you to increase your profits, as long as you are aware of the positive and negative effects it has. But don’t worry, if you learn how to use it appropriately, you’ll see better returns on your investments.
In this article, you will find everything you need to know about leverage trading for beginners.
Basic terms
First of all, we need to understand some basic concepts that ground leverage trading.
- Stock: a security that represents the percentage of ownership someone has in a company. Stocks are both bought and sold on the stock market.
- Buying Power: the amount of money available an investor has to buy stocks.
- Brokerage Company: acts as an intermediary in the negotiations of financial securities and stocks listed on the market.
Read also: Financial lingo 101: Key investment terms you should know
What is leverage?
Ok, now that we’re clear on the basics, let’s dive in.
In the business world, leverage is a term used to refer to the process in which a company can buy new assets for its creation or expansion with borrowed capital.
How does leverage work? Let’s see an example:
You want to start a lemonade business in your neighborhood. All the assets you need are lemons, sugar, water, plastic cups, pitchers, and a stand with signs. To acquire all of this, you’ll need a total of $50. The problem is that you only have $25 in your savings account; therefore, you ask your mother to lend you the other half of the investment. She loves you so much that you get that loan no questions asked. Very excited, you buy all the things you need and the business starts running.
After a week of selling lemonade at your new stand, you’ve earned $80. You go back to your mother and return the $25 she lent you at the beginning and put the initial $25 back in your savings account. Check your final balance, and you’ll find a profit of $30!
There it is, you created a great lemonade business thanks to leverage!
Now that we know the basics of leverage, let’s get deep into it and learn about leverage trading for beginners.
What is leverage trading?
Leverage trading, also known as margin investment, is a tool that helps investors increase their buying power and use less of their own money in the total amount of an investment. This is possible because the trader uses credit given by a brokerage firm, so they only pay a certain percentage of the full value of the deal.
If you search the web for popular opinions, chances are you might find that different people say using leverage is nothing but a quick way to lose your money and increase the risk in trading. There are many warnings about this investment method, but the truth is that professional traders use margin power because it brings them many advantages and it is a very efficient way to use their capital.
Benefits of using leverage trading
In a nutshell, these are the main benefits you may expect from using leverage:
- You can invest more money by using less of your capital.
- It is a way to increase the profit of your investments.
- You can work with borrowed money and increase your revenues from it.
Risks of using leverage trading
There are not many disadvantages related to leverage trading. Nevertheless, you need to pay special attention to its main risk.
If stock prices move against the predictions you’ve made, the potential loss could increase. Investing with leverage sets a greater risk for your money because, as you are using capital that is not yours, you can end up losing more than your initial investment.
Leverage trading in action
To have a better understanding of how leverage applies to the stock market, consider this simple example.
Let’s say you are an investor looking to buy $1,000 worth of stocks. Perhaps you don’t have that amount of money just sitting in your savings account, so you start searching for leverage options.
If you use leverage trading, you only need to have a portion of the total amount in your capital. It is recommended that you have at least 50% of the money you’ll invest. Therefore, in this example, you would need only $500. The other half of the initial investment would be loaned by your broker.
Supposing that stock prices jump 25% after you buy them, the initial value of your investment will increase to $1,250. At this moment, you could sell your stocks and return the $500 back to the brokerage firm and put your $500 back in your savings account, which means you made $250 worth of profit!
Using the same example, what would happen if the stock prices drop? Let’s say they drop 25%. The total value of the investment is reduced to $750. After you return the $500 you borrowed from your brokerage firm, you’ll only have $250 left, meaning that you had a total loss of $250 (insert sad emoji here).
As you can see, it’s possible to win or lose, so it’s recommended to be sure about what stocks you’ll invest in. Leverage trading requires a process of analysis and research in order to get the best possible results out of it.
In conclusion
Leverage trading may seem like a very difficult topic to understand, but we hope we’ve shown you that it doesn’t have to be. It is an investing tool that can help you (an investor) to have more buying power and pay less money than the total amount of an initial investment. This is all possible thanks to loans from brokerage firms.
Like any other investment tool, it has different risks you may need to be aware of. However, leverage trading is used by a lot of professional traders for its efficient results.
You too can start using the power of leverage trading! With FlexInvest, you can opt for margin plans while investing in global stock markets.
