We use leverage to refer to a form of borrowing to increase the amount of money destined to a trade or investment. In other words, the proportion of a trade or investment financed by our own capital and credit.
What is it?
We use leverage to refer to a form of borrowing to increase the amount of money destined to a trade or investment. In other words, leverage is the proportion of a trade or investment financed by our own capital and credit.
The term ''leverage'' has its roots in the verb "to lever" => ''lift or move something with the help of a lever.''
As we are going to see, this concept is not very far from the meaning of financial leverage, which uses this mechanism as a lever to increase investment.
An everyday example
When you buy a flat, if you do not have 100% of the capital for the purchase, you need to leverage the transaction by getting a mortgage to pay the total amount of the purchase.
However, before the bank will offer you a mortgage, you will be asked for a deposit, typically 20% of the total price. If the property costs 100,000 €, the bank will lend you 80% (80,000€), and you will have to put up the remaining 20% (20,000€).
By paying the deposit for the property (20,000€), and thanks to the leverage provided by the bank (80,000€), you will able to pay the full amount of the property, thus acquiring a good for 20% of its value, and indebting yourself for 80% of it.
In this case, the leverage used would be 5:1. In other words, for each 5€ in value of the asset, you have put forward 1€.
And in the financial markets?
Trading with leverage means trading assets, such as Forex or CFDs, with more money than the one reflected on your account's equity (balance +/- open P&L).
To be able to make use of leverage, the broker provides you with a temporary loan which will allow you to do trading with larger positions than what you could normally do with the funds in your account.
The most common way of expressing leverage is with a multiplier. (200:1; 50:1; 20:1; etc).
How does this work at Darwinex?
When you open a trade with Darwinex, we will retain part of the value of the trade as a deposit, also called margin.
This percentage varies depending on the asset traded and the classification of the trader as retail or professional and could be between 0.5% and 20% of the trade value.
Furthermore, this percentage could be modified if there are events expected which could result in a peak in volatility due to a high impact news release accompanied by the uncertainty of its results.
Margin and Leverage
Leverage and margin refer to the same concept, but from slightly different angles:
- The margin is the guarantee that the broker requires to open leveraged positions and is expressed as a %.
- The leverage is the consequence of using margin and is expressed as a multiplier.
Advantages and disadvantages of leverage
The main advantage of leverage is that it gives you the chance to grow your account quicker, provided that you manage the account well.
The main disadvantage is the increase in risk that is implied by trading with high leverage, which can result in significant losses that may exceed the initial deposit.
At Darwinex we recommend a moderate and wise use of leverage, as well as appropriate risk and capital management.
Do you want to learn more?
To know more about what percentage of the trade value is retained as a margin when you open a trade, you can visit the following links depending on the asset class (forex, indices, commodities, and stocks), and look at the ''margin'' column.