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. However, your profit or loss is calculated based on the full value of your trade, so your losses can exceed your initial outlay.
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 $1.
To open a conventional trade with a stockbroker, you would be required to pay 1000 x $1 for an exposure of $1000 (ignoring any commission or other charges). If the company’s share price goes up by $0.20, your 1000 shares are now worth $1.20 each. If you close your position, then you’d have made a $200 profit from your original $1000.