A financial market is a very complex and diverse field that requires specific knowledge and skills in order to make the process beneficial. There are many technical features and a thorough understanding of these tools can result in an effective trading process. One of those tools is leverage, which is also quite controversial. There are many different opinions on the use of leverage, and for starters, the main idea behind its use is that it gives people the ability to trade a large number of contracts and stocks with a small amount of money.
After hearing this some of you might think this is a great opportunity, while a lot of people will think something won’t be as easy as it looks. However, in the majority of cases, newbies in the market are advised not to start with high leverage especially in markets such as options and warrants markets. And in turn, advanced traders in the market will respond to this argument with the fact that not all markets are equally vulnerable to leverage and in many cases it is quite beneficial.
Leverage and risk factors
To describe the whole lever mechanism and put them in simple words, it is considered to be the risk factor due to the fact that it increases the possibilities of profits as well as it can also worsen the losses.
The specific example will make it clearer. For example, if the trader tries to start with an amount of $ 1000 and the brokerage firm advises leverage of 1: 100, the potential profit will be 100,000 as well as the potential loss. In the perfect scenario, it is better for traders to have the opportunity to lose the same amount that they started with. No doubt the risk of losing 100,000 is too great, even when starting out with thousands of dollars, but the winning prize must also be taken into account.
One of the important aspects to consider in this regard is the brokerage company itself and its performance in the market. The best way to check the performance and capabilities of the business is to seek a review with detailed information on all features and tools. For example, XM Forex Broker Review shows that the company has various payment methods as well as advanced software, which increases the general assumption about the company. However, in terms of leverage capabilities, the potential client should measure the financial leverage of the business.
Leverage – explained
Leverage, stock trading or just simply leverage is when traders trade with borrowed money and start trading with it. The amount of debt and the size of leverage are directly proportional to each other. As the number of levers increases, it becomes evident that paying off debt in the event of failure becomes more and more difficult. It is not the same as taking out a loan to buy a car because the bank gives you the loan amount they calculated that you will be able to repay. However, in the case of leverage, you are borrowing money to buy a financial asset that you expect the price to rise and that you will be able to pay on your own.
However, on the other hand, leverage also gives traders the opportunity to make the most of the current situation. Surprisingly or not, the use of leverage can also be used as an opportunity to reduce certain risks. For example, if the trader is willing to buy 10,000 shares of an individual stock, which is priced at $ 5 per unit, the required trading capital in this case is $ 50,000, which is a risk. rather important. What leverage does, in this case, is it gives the opportunity to earn the same potential profit, only risking about $ 2,500 to say.
Measure financial leverage
It is not easy for the brokerage firm itself. Managers, shareholders and lenders need to thoroughly analyze the risks the business bears, which means they need to know everything about the financial indebtedness of the business.
The financial leverage of a given company can be simply measured using the rate of endettement. This simple formula shows the probability of the business when the business has been able to meet the debt obligations. It also shows the capabilities, whether the business can take on debt to grow or not.
How leverage works
The main reason companies offer leverage to clients is to get as many financial projects as possible. In this case, the main objective is to make the most of the opportunities of asset trading. The cost of debt would be much higher than in the case of using leverage.
Due to the fact that the process is not straightforward, there are two main factors that need to be taken into account. The first being the fact that the asset will earn enough to make the payments on the debt, and the second being the fact that the volume of the asset will not drop.
For example, the business makes the decision to buy another business and take out a loan for it, only because it believes that the profits that will be made after the purchase will overlap with the loan amount. Or in the case of starting a new project, it must be believed that the expenses will not exceed the amount of the profits.
However, there is always a risk that something will go wrong since it is impossible to calculate the exact result. In this case, the business will end up with worthless assets. Deciding on the use of financial leverage and whether it is worth it or not is a very difficult decision to make.
The possibility of making a lot of money seems too good, however, if something goes wrong the brokerage firm will contact you to put a margin on the checking account to cover the losses. Other than that, it is a common practice when brokerage firms ask you to keep a specific amount of money in your brokerage account, in order to pay for margin calls, in case something does not happen. according to the plan.
Interesting related article: “Introduction to Forex Trading: Leverage”