What Is Leverage in Trading? A Simple Explanation

What Is Leverage in Trading? A Simple Explanation

Leverage is a fundamental concept in trading. It allows participants to control a larger position in the market with a smaller initial deposit. This is achieved through borrowing provided by a broker.

While leverage can make markets more accessible, it also increases risk exposure. Understanding how leverage functions is important before participating in any leveraged product, such as CFDs.

Risk Warning: CFDs are complex instruments and come with a high risk of losing all your invested capital. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your investment.

How Leverage Works

Leverage is expressed as a ratio, such as 1:10, 1:20, or 1:30. The ratio indicates how much larger a market position can be relative to the margin deposit required.

For example, with 1:10 leverage, a margin of $1,000 allows control of a $10,000 position. The broker provides the additional exposure, but the participant is responsible for meeting margin obligations.

Margin and Its Role

To use leverage, a margin deposit must be placed. Margin is a portion of the trade’s total value that serves as collateral.

Key Margin Terms

  • Initial margin: The amount required to open a position
  • Maintenance margin: The minimum balance needed to keep the position open
  • Margin call:  If your account equity falls below the maintenance margin requirement, you will receive a margin call. To resolve it, you generally have three options:
  1. Add Funds: Deposit additional cash or margin-eligible securities into your account.
  2. Close Positions: Reduce your exposure by closing some of your open positions.
  3. Wait for Market Correction: In some cases, if the market moves back in your favor, your equity may increase enough to cover the margin call. However, this approach is highly risky. If the correction does not occur—or is insufficient—your broker may liquidate your open positions to protect against further losses.

These safeguards ensure that leveraged positions are supported by sufficient collateral.

Example of Leverage in Practice

Consider a participant opening a position in an index CFD with leverage of 1:20.

  • Total position size: $20,000
  • Required margin: $1,000
  • Broker provides: $19,000 exposure

If the market moves in either direction, the change in value is applied to the full $20,000 exposure, not just the $1,000 deposit. This is why leverage magnifies both risk and responsibility.

Leverage Ratios Across Markets

Different asset classes and jurisdictions allow different leverage limits, for example in the EU leverage levels for retail clients are set as follows:

Asset Class Common Retail Leverage Notes
Major Forex Pairs Up to 1:30 Often capped by regulation
Indices Up to 1:20 Varies depending on region
Commodities 1:10 to 1:20 Energy markets may be lower
Shares (CFDs) 1:5 Generally more restricted

Leverage availability may vary significantly by jurisdiction. For example, in some regions brokers may offer higher or lower maximum levels, depending on local regulations and client classification.

Risks of Using Leverage

Leverage increases market exposure, which means risks are amplified.

Main Risks

  • Rapid changes in the account balance, due to larger exposure
  • Margin calls, if account equity drops below required levels
  • Potential for total loss of margin, if positions move significantly against the participant

Because of these risks, regulators require brokers to display clear warnings about leverage.

Managing Leverage Responsibly

Educational approaches to managing leverage include:

  • Understanding the exact leverage ratio applied to each market
  • Monitoring account equity and margin levels frequently
  • Using stop orders to limit exposure to sudden market moves
  • Avoiding excessive leverage that may increase vulnerability

Although risk management tools exist, they cannot remove all risks associated with leveraged trading.

Regulatory Oversight

Many regulators set strict leverage limits for retail clients. For example, in the European Union, the maximum leverage for major forex pairs is capped at 1:30. In other jurisdictions, such as South Africa, leverage limits may differ and are generally set by the broker, in compliance with local conduct standards.

These limits are designed to protect participants by reducing the possibility of rapid and uncontrollable losses. Professional clients may have access to higher ratios, but they forfeit some retail protections.

Final Thoughts

Leverage is a core concept in modern markets. It allows positions larger than the initial margin deposit, but also magnifies the risks of trading.By understanding how leverage and margin function together, participants can better appreciate the responsibilities and potential exposures involved in trading leveraged products.

<p>The post What Is Leverage in Trading? A Simple Explanation first appeared on TradeFT.</p>



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