What are the Dangers of Leverage?
Trading on financial markets has never been more popular than this year, as shown by the new registrations at international trading platforms. The private investor segment in particular seems to be exploding. No wonder, as the economic crisis in 2020 and the associated financial policy measures are also causing increasing mistrust among private investors of the stability of the leading currencies.
Investors fear a rapid decline in the value of their savings due to imminent hyperinflation. For this reason, investments in shares, indices and other value investments are constantly rising, and precious metals and cryptocurrencies in particular are also being used as investment opportunities.
Leverage trading in particular is becoming increasingly popular. Whoever borrows money from brokers to trade with larger positions in order to take larger profits, however, is walking on thin ice. This is because trading with leverage involves considerable risks and traders should definitely know what they are doing and have sufficient experience in this area. Especially in the field of cryptocurrencies high leverage is offered by many international BTC margin trading brokers.
In this article we will go into detail about trading with leverage.
Why Using Leverage?
Most investors and traders, and those who read these types of articles have at least heard what leverage is, even though many doubt its true definition, it is nothing more than a person’s ability to get into debt, to put it simply.
Many believe that the idea of investing through leverage (that is, using other people’s money) is smart or sophisticated. Others, on the other hand, see the use of someone else’s money as a greater risk.
Of course, if we look at the facts or figures when using leverage, it seems compelling. The most popular form of leverage is through commercial debt. This is preferred over borrowing money from financial institutions or their potential investments.
Brokerage firms, for example, are required to hold at least 50% of their capital in lace, so if you have 5,000 euros in cash, you can invest up to 10,000 euros. Half of the funds are margin (borrowed money).
Those in favor of leverage, give a crude example like the following: if a share is worth 50 euros, I can only buy 100 shares using all the money available. Let’s think that we would be earning 300 euros if the price of the shares goes up by three points. But if we use the margins and buy 200 shares, the same three-point increase offers a profit of 600 euros, or twice as much.
With this example, which tends to deceive inexperienced investors, many who want to make easy money are caught and fall into trouble after leverage.
This is easily disproved if we look at it from the other side of the leverage equation. If their 50 euro values lose three points, they are down by 300 euros and the stock is worth 47 euros. If you have used the margin and bought 200 shares, the three-point drop is worth a loss of 600 euros.
Another thing that also happens here. Your EUR 10,000 investment would be reduced to EUR 9,400, but half the original, or EUR 5,000 you borrowed and still have to pay back. However, based on the current value of 9,400, you are only allowed to borrow half, or 4,700. So you will receive a demand to deposit 300 euros more into your account to maintain that 50-50 relationship between the money and the leveraged money.
Mitigate The Risks Of Leverage
In the current crisis many investors rely on crypto currency trading, as published at rosarionet.com.ar. Many of them use leverage. The truth is, leverage increases risk and can destroy the value of your capital, as long as values fall. Here are some solutions to help mitigate that risk:
Buy safe investments if you have to use the margin
In volatile times buy only to protect the value of your shares
Use of buying and selling options to control the entire stock, but without having to buy it.
- Always consult with experienced traders who may consider some additional strategies
- Use stop-loss orders to reduce losses and reduce the impact of the decline in value on your account
- If not experienced in the stock market, use mutual funds, ETFs (exchange-traded funds) and index funds, or other vehicles to spread risks, which could reduce the risk of leverage.
Finally, what you should keep in mind is that all leverage is governed by the following law: leveraged securities will grow faster than all deposits, but they also lose value more quickly and can create serious problems in your accounts. If you cannot accept the risk of leverage, you should avoid it altogether. If you can accept the risk, you must find a way to cover that risk.