What is Leverage? Opportunities and Risks

How does leverage work?

Leverage is not a "loan" provided by the broker, but a mechanism that multiplies the position size you hold in the market against collateral (margin). With 1:100 leverage, you can open a position worth $100,000 with a collateral of $1,000. This means that both profit and loss are calculated on the $100,000 position — your collateral is merely the minimum amount required to open the position.

This point is critical: leverage does not change the size of your profit/loss, it only reduces the margin required to open a position of the same size. So the real determining factor is the position size, not the leverage ratio itself.

Why is high leverage risky?

Because high leverage makes it possible to open large positions with low margin, it can wipe out an account very quickly if used undisciplined. For example, if you put almost your entire account as margin into a single position with 1:500 leverage, even a small percentage price movement can consume your margin and lead to the automatic closure of your position (margin call/stop-out).

This does not mean leverage is "bad" — professional investors also use high-leverage accounts. The difference is that they open the position determined according to the risk management rules discussed in our previous article (such as %1-2 risk per trade), not the maximum position allowed by leverage.

Practical approach

• –Think of leverage not as "how large a position can I open", but as "how little margin can I trade with".
• –Set your position size according to your risk management rules, not according to the maximum allowed by leverage.
• –If you are starting out, beginning with a low-to-medium leverage account reduces the risk of a margin call and makes the learning process less stressful.