What is margin trading and leverage?

What is margin trading and leverage?

Simply put, margin trading is a situation when a trade is made for money borrowed from a third party.

Leverage shows the ratio of borrowed funds to own deposits. Let’s take a closer look. Imagine you need $2000 to make a trade, but you have only $1000. So you borrow the missing money against your deposit. This ratio of your own money to the value of the loan is called leverage.

In your case, it’s 1:2. But it may also be 1:10, 1:50, 1:100, etc. The higher the leverage, the less your own money you put into the deal. For example, when opening a deal for $1000 with a leverage of 1:1, you need to invest $1000 of your own money. But when trading with leverage of 1:50, the amount of deposit will be reduced to $40! Leverage is also a great way to increase the value of the whole trade.

Suppose you want to buy some pens for a very good price. One pen costs a dollar. When trading without leverage, you can buy 1000 pens for your $1000. But with 1:10 leverage, you can raise the trade value to $10,000 and buy 10,000 pens with your $1000 investment. If the price of a pen goes up, say, at least 5 cents, you can sell them and increase your deposit to $1500!

But if the market goes backward and a pen will lose 10 cents in price, you will lose your deposit. To calculate the price drop at which the entire deposit is lost, use a simple formula: Leverage allows you to open trades for large amounts, but the risk increases proportionally. When used wisely, the lever may quickly increase your capital!

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