Leverage trading in stocks refers to buying stocks by borrowing funds on margin and trading in your stock trading account. Also known as “margin trading,” it involves placing a small amount on deposit and borrowing funds on that basis to fund stock trades.
You must note that the interest costs on leverage are pretty high in India. Hence, leverage trading can be lucrative only if you are a seasoned trader who can read the market very well and is aware of all the risks. Otherwise, leverage trading can be extremely dangerous.
The leverage ratio is the ratio of your entire exposure to the margin deposit placed by you. In your online trading account, you can leverage stocks, derivatives, forex, indices, ETFs, etc. Leverage trading compounds the risk and also increases the potential for profits. Brokers provide intraday leverage, giving an intraday margin for trading that varies from 4-8 times the trading capital you have. Some discount brokers even provide margins that range from 10-20 times your capital.
The Advantages and Disadvantages of Leverage Trading
The following are the advantages and disadvantages of leverage trading:
- Increasing your financial stake: Assuming leverage increases your financial means beyond your own resources, you get the opportunity to assume larger positions and maximise your profit potential.
- Mitigating the effects of low volatility: During times of low volatility, when many profitable opportunities do not abound due to a lack of market volatility, leverage allows you to increase your existing profitable opportunities by deploying a larger amount of cash.
- Portfolio expansion: With an increase in the amount of money at your disposal, you can increase your portfolio size. It enables you to access additional investment options.
- One of the riskiest trading strategies: if your portfolio positions are at a loss, you will be losing not only your capital but also the accumulated debt of the leverage with interest and fees you have to pay the broker.
- Losses magnified: losses are magnified by using leverage as they will be incurred on both your capital and the borrowed capital.
- Newcomers have no chance: as mentioned before, leverage strategies require exceptional expertise and market knowledge with an accurate predictive ability of market trends. Even seasoned traders can make losses with leverage. Newcomers have very little chance of succeeding using leveraged strategies.
- Not suitable for traders with a low-risk appetite: if you are a trader with a low-risk appetite, leverage is definitely not for you. Leverage may increase the potential for profits but also magnifies the risk of investing.
- Jeopardises portfolio investments: leverage puts your portfolio at risk. When your portfolio positions are in profit, you will not feel the negative effects of leverage, but if there is a trend reversal, the losses will magnify, and your portfolio will be at risk.
If you are a professional trader with an exceptional ability to read market trends and volatility correctly, you may consider assuming leverage. But if you are a novice trader, it is better not to do margin trading, which may put your own investments at risk.
Disclaimer: This blog is not for investment advice. Trading and investing in the securities market carries risk. Please do your own due diligence or consult a trained financial professional before investing.