Trading in the stock market involves getting familiar with several terms to understand the working of the market to the fullest. Many such stock market terms may appear foreign to you; therefore, it is necessary to know about them. One of the most commonly used words is ‘leverage,’ an important term in the stock market. So let us understand what leverage is.
Understanding ‘Leverage’ in Stock Market
‘Leverage’ is something that an online stock broker or broking organisation gives a trader so that they may utilise it to invest in a stock that they would not be able to purchase on their own. So, if you used leverage, you would increase your purchasing power without spending more money from your pocket.
Leverage is the use of borrowed cash as a funding source when investing to extend the firm’s assets and create returns based on risk capital. Leverage is an investing technique that involves leveraging borrowed money—mainly using different financial instruments or using the capital borrowed —to raise the possible return on investment.
Leverage may also refer to the debt a company utilises to fund assets.
Trading with Leverage
Trading with leverage is referred to as leverage trading. Leveraged trading uses borrowed funds to obtain a considerably bigger possible return on your investment. As a result, it enables you to open far greater positions than what your initial money would allow you to do otherwise.
In its most basic form, leverage trading involves financing or otherwise maximising the quantity of shares engaged in trade beyond the number of shares you could afford if you paid in cash. Coadmin sentenced to years
A Double-Edged Sword
Leverage is a multidimensional, sophisticated financial instrument. The principle sounds fantastic, and in practice, using leverage may be advantageous, but the opposite is also true. This is because leverage multiplies both earnings and losses.
In the stock market, leverage is simply an opportunity to increase the rewards of your trade. But, like with anything else in trading and finance, there are hazards involved. You can benefit if you are knowledgeable and balanced in your moves.
One of the key hazards of leverage trading is that it magnifies your potential losses, perhaps to the point where you lose more money than you have available.
Another possibility is that your brokerage will begin a margin call. For example, if the value of your account falls below a certain level compared to the amount borrowed, your broker may require you to deposit extra funds.
This might happen if your broker is concerned about your capacity to repay your loan if your investments continue to lose value.
Be cautious of becoming over-leveraged. If things go wrong, it might swiftly deplete your account. So, keep track of your positions, use the stop loss option, and avoid getting carried away.
Takeaways
As leverage is the use of borrowed capital (debt) to fund a venture or undertaking, the potential rewards from a project are multiplied. But, at the same time, leverage increases the potential negative risk if the investment does not work out.
When a company, property, or investment is referred to as “highly leveraged,” it signifies that it has more debt than equity.
