Basics of using leverage in trading

Leverage is a tool that allows traders to control larger positions in the market with less of their own capital. This way, they can potentially increase their profits but also their losses. It is important to understand how leverage works in order to effectively manage the risks associated with its use.

1. What is leverage?
   
2. What is margin?
   
3. Costs of leverage: Overnight financing

What is leverage?

Leverage is a mechanism that allows traders to control larger positions in the market than their own capital would otherwise permit. This means that with a smaller amount of personal funds, they can trade larger volumes. This effect can increase potential profits, but also losses.

What is margin?

Margin is the amount of money a trader must deposit into their trading account as collateral to open a position. It is a percentage of the total value of the trade and serves as a guarantee for the broker that the trader has sufficient funds to cover potential losses.

Leverage costs: Overnight financing

When using leverage, a broker may charge fees for financing the position overnight. These fees are known as swap or rollover fees, and they depend on the difference in interest rates between the two currencies in the currency pair you are trading. These costs can accumulate if you hold the position for a longer period.

Example of leverage usage:

Imagine you have €1,000 and use a leverage ratio of 1:10. This means you can control a position worth €10,000. If the asset price increases by 1%, your profit will be €100. However, if the price drops by 1%, your loss will be €100, which is equal to your initial capital. This example demonstrates how leverage can amplify both potential profits and losses.

Understanding leverage and margin in trading

It is essential to fully understand how leverage and margin work so that you can effectively manage the risks associated with their use in trading.