What is leverage?

Leverage is a facility that enables you to get a much larger exposure to the market you’re trading than the amount you deposited to open the trade. Leveraged products, such as CFDs, magnify your potential profit – but also your potential loss.

Leverage is a key feature of CFD trading, and can be a powerful tool for a trader. You can use it to take advantage of comparatively small price movements, ‘gear’ your portfolio for greater exposure, or to make your capital go further. Here’s a guide to making the most out of leverage – including how it works, when it’s used, and how to keep your risk in check.

How does leverage work?

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. 

Unleveraged

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.

Or you could have opened your trade with a leveraged provider, who might have a margin requirement of 10% on the same shares.

Here, you’d only have to pay 10% of your £1000 exposure, or £100, to open the position.

If the company’s share price rises to 120p, you would still make the same profit of £200, but at a considerably reduced cost. 

If the shares had fallen by 20p then you would have lost £200, which is twice your initial deposit. 

 

Leveraged

Find out more about how leverage affects your trading

A leveraged product

The majority of leveraged trading uses derivative products, meaning you trade an instrument that takes its value from the price of the underlying asset, rather than owning the asset itself.

The main leveraged product used for leveraged trading is Contracts for difference (CFDs).

Contracts for difference (CFDs)

An agreement with a provider to exchange the difference in price of a particular financial product between the time the position is opened and when it is closed.

Find out more about trading CFDs with IG

Which markets can you use leverage on?

Some of the markets you can trade using leverage are:
 
  • Shares 
    A share is a unit of ownership for a particular company, and is usually bought and sold on a stock exchange. You can use leveraged products to open positions on thousands of shares, from blue chips like Apple and Facebook, to penny stocks. 
     
  • Indices
    An index is a numerical representation of the performance of a group of assets from a particular exchange, area, region or sector. As indices are not physical assets, they can only be traded via products that mirror their price movements – including spread betting, CFD trading and ETFs. 
     
  • Forex
    Foreign exchange, or forex, is the buying and selling of currencies with the aim of making a profit. It is the most-traded financial market in the world. The relatively small movements involved in forex trading mean that many choose to trade using leverage. 
     
  • Cryptocurrencies
    Cryptocurrencies are virtual currencies that can be traded in the same way as forex, but are independent of banks and governments. Leveraged products allow traders to gain exposure to major cryptocurrencies, such as bitcoin and ethereum, without tying up lots of capital. 
Find out more information on the markets you can trade using leverage.

Benefits of using leverage

Provided you understand how leveraged trading works, it can be an extremely powerful trading tool. Here are just a few of the benefits:

  • Magnified profits. You only have to put down a fraction of the value of your trade to receive the same profit as in a conventional trade. As profits are calculated using the full value of your position, margins can multiply your returns on successful trades – but also your losses on unsuccessful ones. 
    See an example of magnified profit
  • Gearing opportunities. Using leverage can free up capital that can be committed to other investments. The ability to increase the amount available for investment is known as gearing
  • Shorting the market. Using leveraged products to speculate on market movements enables you to benefit from markets that are falling, as well as those that are rising – this is known as going short
  • 24-hour dealing. Though trading hours vary from market to market, certain markets – including key indices, forex and cryptocurrency markets – are available to trade around the clock

Drawbacks of using leverage

Though spread betting, CFDs and other leveraged products provide traders with a range of benefits, it is important to consider the potential downside of using such products as well. Here are a few key things to consider:
 
  • Magnified losses. Margins magnify losses as well as profits, and because your initial outlay is comparatively smaller than conventional trades, it is easy to forget the amount of capital you are placing at risk. So you should always consider your trade in terms of its full value and downside potential, and take steps to manage your risk
  • No shareholder privileges. When trading with leverage you give up the benefit of actually taking ownership of the asset. For instance, using leveraged products can have implications on dividend payments. Instead of receiving a dividend, the amount will usually be added or subtracted to your account, depending on whether your position is long or short
  • Margin calls. If your position moves against you, your provider may ask you to put up additional funds in order to keep your trade open. This is known as margin call, and you’ll either need to add capital or exit positions to reduce your total exposure
  • Funding charges. When using leverage you are effectively being lent the money to open the full position at the cost of your deposit. If you want to keep your position open overnight you will be charged a small fee to cover the costs of doing so

Leverage and risk management

Leveraged trading can be risky as losses may exceed your initial outlay, but there are numerous risk-management tools that can be used to reduce your potential loss, including: 

Stops

Attaching a stop to your position can restrict your losses if a price moves against you. However, markets move quickly and certain conditions may result in your stop not being triggered at the price you’ve set.

 

Guaranteed stops

These work in the same way as basic stops, but will always be filled at exactly the level you’ve set, even if gapping or slippage occurs. If your stop is triggered, there will be a small premium to pay in addition to normal transaction fees.

Limited-risk account

This type of account ensures that your losses will not exceed the initial deposit required to open the trade, as all positions must have a guaranteed stop attached.

Using stops is a popular way to reduce the risk of leverage, but there are numerous other tools available – including price alerts and limit orders.

Learn more about managing your risk 

What is a leverage ratio?

Leverage ratio is a measurement of your trade’s total exposure compared to its margin requirement. Your leverage ratio will vary, depending on the market you are trading, who you are trading it with, and the size of your position. 

Using the example from earlier, a 10% margin would provide the same exposure as a £1000 investment with just £100 margin. This gives a leverage ratio of 10:1. 

Often the more volatile or less liquid an underlying market, the lower the leverage on offer in order to protect your position from rapid price movements. On the other hand, extremely liquid markets, such as forex, can have particularly high leverage ratios. 

Here’s how different degrees of leverage affect your exposure (and thus profit potential and maximum loss) for an initial investment of £1000:

 

Unleveraged trading

Leveraged trading

 

1:1

20:1

50:1

100:1

200:1

Investment

£1000

£1000

£1000

£1000

£1000

Exposure

£1000

£20,000

£50,000

£100,000

£200,000

 

When researching leveraged trading providers, you might come across higher leverage ratios – but using excessive leverage can have a negative impact on your positions.

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Example

Example of magnified profit

Take our example from earlier. With a margin requirement of 10% and a full market exposure of £1000, you’d make a 200% profit on your initial outlay if the market rose by 20p – compared to just 20% from the conventional trade. But remember that it if the markets moved against you, your losses would be calculated using the same percentage. 

Compare your profit to yout initial outlay if you used conventional trading:

And now with leverage trading:

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