What Is Leverage in Trading? A Beginner's Guide
Learn what leverage means in trading, how it works, and why it increases both potential exposure and risk.
- 7 min read
- For beginners
- Educational
- Lesson 1 of 3
Leverage is one of the most important concepts to understand before trading forex or CFDs, and it's one of the three spotlight topics featured at the start of this Risk Management module, alongside Risk vs Reward and What Is a Margin Call.
This guide revisits and expands on the introduction to leverage first provided in the Trading for Beginners module, with a sharper focus on risk implications.
What Does Leverage Mean?
Leverage allows a trader to open a position that is larger than the amount of capital they have deposited, by borrowing the additional exposure from their broker. It's typically expressed as a ratio, such as 1:10 or 1:100, indicating how much larger a position can be relative to the trader's own capital (margin) committed to it.
How Leverage Works in Practice
If a trader uses 1:100 leverage, for example, a deposit of a given amount could control a position 100 times larger than that deposit. This means that price movements are effectively magnified in terms of their impact on the trader's account, relative to the capital actually committed.
Why Leverage Increases Both Exposure and Risk
Because leverage magnifies the effective size of a position, it magnifies both potential gains and potential losses relative to the capital deposited. A relatively small price movement against a highly leveraged position can result in a loss that is large relative to the trader's actual deposited capital, potentially including the entire deposited amount.
Leverage and Margin
Leverage is directly connected to the concept of margin — the amount of capital required to open and maintain a leveraged position. This connects to the other two spotlight topics in this module: Margin, Margin Level and Margin Call, and Risk vs Reward, both of which build on the leverage concept introduced here.
Summary
Leverage allows a trader to control a larger position than their deposited capital alone would allow, magnifying both potential gains and potential losses. Because of this magnification effect, leverage significantly increases risk, and understanding it thoroughly is an essential foundation before exploring margin and risk-to-reward concepts.
Frequently Asked Questions
Leverage magnifies both potential gains and potential losses proportionally; it does not favour one direction over the other.
Risk Warning
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