Leverage works by using a deposit, known as margin, to provide you with increased exposure to an underlying asset. Essentially, you’re putting down a fraction of the full value of your trade – and your provider is loaning you the rest.
Your total exposure compared to your margin is known as the leverage ratio.
For example, let’s say you want to buy 1000 shares of a company at a share price of 100p.
To open a conventional trade with a stockbroker, you would be required to pay 1000 x 100p for an exposure of £1000 (ignoring any commission or other charges). If the company’s share price goes up by 20p, your 1000 shares are now worth 120p each. If you close your position, then you’d have made a £200 profit from your original £1000.
If the market had gone the other way and shares of the company had fallen by 20p, you would have lost £200, or a fifth of what you paid for the shares.